How do you know when you have enough saved for retirement?
Can you give some advice for someone who is 41 years old with a retirement portfolio of ~$1,200,000 (85% in traditional 401(k), 10% in Roth IRA, 5% in brokerage account) and wishes to retire by 65 years of age (ideally earlier)? Should I stop contributing to traditional 401(k) (I feel I have enough) and put all 15% into a Roth 401(k) (we are above the limit for a Roth IRA)? Do you feel I have enough saved in retirement savings? Should I instead only contribute the minimum to get the company match and then start to divert the rest of the contribution into other non-retirement investments, or perhaps pay my mortgage off more aggressively (no consumer debt)?
With the multitude of online calculators and investors, it can be confusing to understand exactly what they are assuming and whether they are talking about FV or PV. Some say to use a 10% ROI, 8%, or 5%. To best estimate how much I will have in 24 years, should I use a 7% return? And then to account for inflation, divide that total in half to get a close ballpark of what I can expect to have at retirement in present dollars? Or should I use a higher (or lower) ROI?
I am trying to figure out at what point I have enough saved for retirement where I can start to perhaps save for a bigger house or invest my money elsewhere. I know it's based on how my wife and I wish to live while in retirement, but my rough calculations tell me that I should be able to withdraw 4% yearly in retirement and have roughly what I currently make in salary today.
Edward Thorp answered this question in his excellent book published earlier this year. If you can afford to live on 2% of your total net worth which you withdraw each year, then you have saved enough for retirement. Otherwise, you need to save more or to more intelligently do Roth conversions and other tactics to reduce your long-term taxes, while using a more disciplined approach to buying unpopular assets while selling trendy ones.
If you have 85% of your net worth in a traditional 401(k) then it is not really worth as much as you think, since you are going to have to pay taxes on all of the before-tax money when you withdraw it. It is probably only worth about 60% of its notional value after paying federal and state income taxes (a bit more if you live in a state with no state income tax).
Withdrawing 4% a year probably won't work in the long run. It might, but chances are that your total net worth will eventually get dangerously low. If interest rates become much higher in the future, which is possible, then that could be more successful.
Do not assume something unrealistic like a 7% return. You could suffer severe losses whenever we have the third U.S. stock-market collapse since 2000 which could happen sooner than you expect.
You didn't mention an HSA (health savings account). Be sure to put in the family maximum of 8750 annually. There are no income restrictions and the amount is fully deductible from your income on Form 1040, plus you can withdraw all of it and all gains completely tax-free when you reach age 65.
Thank you for your question and for being proactive with your retirement planning at age 41. You are exactly right! Retirement tools can often make the task of retirement planning more confusing. I have been helping individuals with retirement question for almost 20 years and I always ask, "How can I help simplify this process for my clients?". That's why I came up with term Retirement Number after choosing to work with the tech folks at Riskalyze. They streamlined the number of inputs and combined it with their Risk Number* tool. This simple process can help individuals either planning for retirement or individuals currently retired answer the question, "Am I on track?". The result will provide you with two key numbers, your personal Risk Number (RN) and your Retirement Number number. Yes, it’s that easy. This type of efficient retirement planning can really help you ease the stress of retirement planning down the road.
You have done a great job providing a lot of information that is needed to determine your Retirement number. I have made a couple of assumptions to see if you are on track or not; current income and Risk Number. Based upon your comments, I used 4% of your current retirement portfolio, or $48,000 as your annual income and a RN 43, which is a translates to annual rate of return of 4.88%. Don't worry if the numbers are not exact for this illustration, the Retirement Number tool can be easily updated as soon as you complete a personal RN questionnaire. You can learn more about RN or Retirement Number from any independent advisor that uses the Riskalyze applications or you can visit my website.
Based on your information, I could fill in the following inputs:
Current Investment Amount: $1,200,00
Month Savings (assuming 401k max plus company match): $2,000
Birth Year: 1976
Retirement Year: 2041
Monthly Withdrawal Amount (today’s dollars): $4,000
Life Expectancy: 90
Annual Inflation: 3%
Annual Savings Increase: 2%
Investment Annual Rate of Return: Risk Number 43 or 4.88%
Your Retirement Number: 95%+.
Congratulations! A 95%+ means that you are on track with your stated goals based upon your assumptions. I hope that this information has been helpful in your quest to simplify the retirement puzzle.
* Risk Number is a registered trademark of Riskalyze
A general rule of thumb is to save 15% of your net income in order to build enough savings to live from once retired. That said, it really comes down to what kind of lifestyle you are looking to live at retirement; and beyond. Save aggressively, but be sure to also live today!
Your instinct to question whether you should continue to save into your tradional 401(k) is spot on. "Money is not Math" - - large sums of money in tax qualified accounts leave you with very little tax control on your wealth. Who knows what tax rates will be in the future, or what other changes on distributions will come? Monies in 401k's are not all "yours." Some of that belongs to the IRS; and you should be weary of how much of your total wealth you want out of your "control." Getting the company match is not a bad thing. The numbers may look higher in these types of accounts, but wealth is more about access & spending capacity (distirbution), not just accumalation. The Roth side of your 401(k) may warrant more allocation, as your brokerage account - - you seem to be 401(k) "top heavy."
There may come economic challenges in your life, or great opportunities to take advantage of; and you are going to want to be able to access funds without penalties or loans - - build wealth outside of your 401k. If you invest in a similar fashion as your 401k, you could take advantage of losses, or better tax rates (capital gains and qualified dividend rates), none of these are available to you in your 401(k). This leads me to the other part of your question - - use present value numbers (it creates a more realistic "perspective.") Don't project more than 7%. Real ROI's are not linear. Volatility (even with good diversification) and investment costs' will eat away at your returns so project conservatively. Inflation is relative to where you live, how you live, and what other plans you may have (ie. college etc). Project your returns, and use inflation as a factor on expenses, not as a dollar for dollar reduction on your ROI.
Paying off the mortgage may not be a bad idea, but if you are planning on selling / exchanging for a bigger home - - then delaying may be best. Do you really need a bigger home. Live simply . . . retire earlier, give more! Mortgage debt is not the same as consumer debt. Your home is an asset and interest is dedcutible. You should consider more payments towards your mortgage, if you have 6 months worth of cash reserves, and can still save 15% of income.
Have you considered investing in a business, a franchise, or other start ups in your city, neighborhood? It takes a certain type of person, and you need to do your homework , , but there are many opportunities. If you are an accredited investor (household income of 300k+ if married, or net worth of 1 million, excluding home) check out sites like seedinvest.com. Here too. . .you have to be careful and be patient. Use "extra" dollars (not your serious money) for these types of investing opportunities.
Good luck . . .expect the best, but plan for the worst. You seem to be doing pretty well.
Great questions.. there are thoretical answers and then there's the 'real world'. Given that global asset prices (stocks, bond and real estate) are now standing at all time highs again (not every index mind you), but here in the US we are in the third asset bubble in as little as 17 years. I would be more concerned with this bubble and protecting my net worth. After this current bubble pops, assuming one has taken precautionary steps to protect their assets, you will have all the financial flexiblities to buy assets at 'reduced prices' after the bubble pops. No use assuming a 7% ROI if you are standing in front of a major market decline. Remember, what declines -50% must earn +100% just to get back to breakeven, where you started.. Hope this helps.
You're approaching this the right way in trying to forecast a reasonable inflation-adjusted withdrawal rate in retirement, but the reality is that there are so many assumptions to make that I'd suggest focusing your efforts elsewhere.
For starters, I'm a fan of diversifying the tax profile of your portfolio, so Roth 401(k) contributions are a solid choice. As a side note, if you make Roth contributions you will receive the employer-match in pre-tax form, so each bucket will be funded. Clearly this is largely a tax planning evaluation, so if you'd like more definitive insight it will require a deeper look into your tax situation.
I'm also a fan of not focusing solely on retirement as a financial objective; it's highly plausible that it's more important to focus on strengthening your balance sheet by paying off debt, building a significant after-tax (joint) investment account, buying a house, etc. Unfortunately, it's hard to sign off on a strategy without knowing a bit more about the financial economics of your situation.
In short, if you decrease your 401(k) contributions it's okay as long as that extra capital is finding its way into another part of your financial plan and not being spent. Finding the "optimal" place for these funds would require balancing qualitative objectives and quantitative assumptions, both of which are pretty fluid and impossible to gauge with exactness. I'd likely urge you towards building an after-tax joint investment account in a cost-effective way (if you're making regular contributions and investments, trading costs can mount). If you'd like some ways to reduce your investment costs I'd be happy to give some tips.
Of course, this is for general informational purposes only. If you'd like to talk specifics, feel free to shoot me a call or message.
Adam Harding | Investments & Planning