Planning for retirement can be intimidating! When should you start? How much should you save? How much will you need when you ultimately retire? While there are a lot of unknown variables in retirement planning, one is certain, the sooner you begin saving and planning, the better off you will be - it’s simple math.
Some information that can help you determine the answers to the when & how’s can be found in the 4% Rule.
Since William P. Bengen's widely adopted research paper "Determining Withdrawal Rates Using Historical Data" was published in 1994, a basic tenet of retirement income planning has been that you should not draw down more than 4% of your principal retirement savings annually if your goal is to make your income last for 30 years plus and still have some money left when you die. The 4% rule has been a basic rule of thumb in retirement income planning ever since.
The 4% rule means for every $1,000 of monthly income; you would need $300,000 of retirement savings to support it. You can simply multiply a desired monthly income by 12 to calculate an annualized figure and then multiply again by 25 to come to the amount of retirement savings you need to support it - according to the 4% rule.
($1,000 per month x 12 is $12,000; x 25 is $300,000. 4% is 1/25th of 100%. This is where the 25 multiplier comes from.)
Recently, I asked a client to envision a number that they would need to reach to live comfortably in retirement. They immediately settled on $5,000 per month. I told them about the 4% rule and that based on this rule of thumb, they would need $1,500,000 of retirement savings to support it. We discussed that this assumes they will have no other sources of income like social security or a pension; or assets like an apartment building to generate income, for example. It assumes they need it to last 30 years (or longer) and that they care about leaving money to their spouse or children when they die. The amount of savings they will need for retirement is likely not $1,500,000 but it’s a figure that will help them to think about the future and plan accordingly to hit a reasonable goal.
($5,000 per month x 12 is $60,000; x 25 is $1,500,000)
There is much debate today among researchers and practitioners in the retirement income field on how safe the 4% rule is going into the future as the historical figures that initially influenced William P. Bengen to write his paper have changed. The last 20+ years have seen serious market declines such as the dot com bubble and 9/11 in the early 2000s and the financial crisis of 2008 and more recent sharp market volatility in March 2020 (Covid) and right now (Inflation fears). A large market decline in the early years of retirement has the potential to seriously stunt your long-term retirement income plans. This is known as Sequence of Returns Risk. Therefore, planning to have more than enough assets to sustain your lifestyle and income helps to mitigate sequence of return risk and increases the flexibility in the types of investments you can make with your retirement savings.
Remember, the farther ahead you plan for, the better off you will be. Have a goal in mind in terms of income in retirement. Think deeply about the lifestyle you want to lead and the living expenses that are likely to come with it. The sooner you start, the less you must save and invest each year to hit your target; and therefore, the more realistic hitting your target becomes. And, if you have exceptional earnings and no debt, you can blow these targets out of the water at any age.
A 20-year-old needs to save only $190 per month to have $1,000,000+ of retirement savings at age 65 — versus $435 per month for a 30-year-old — $1,050 per month for a 40-year-old — $2,900 per month for a 50-year-old. (Assuming an 8% annualized rate of return compounded).
Retirement is a lifelong journey! The assets you accumulate along the way will set you up for the future when working for money is no longer your focus and you need your money to do the work for you. A financial advisor can help you to get on and hopefully stay on track to a secure and comfortable retirement.