How Much Will I Need to Retire?

At face value, the question of “how much will I need to retire?” seems simple – you receive an answer in the form of a dollar amount, then you work and invest until you reach that monetary goal. However, real-world experiences tell us that personal financial management does not operate in this simplistic manner. Arriving at a dollar amount answer to this question would require broad assumptions around investment performance, tax rates, retirement spending, cost of maintaining good health, longevity, and a plethora of other factors. What if the assumptions are off? What if a critical component of the calculation is overlooked? If retirement life does not match the arithmetic done decades beforehand then do you go back to work in your 70s or 80s?

The answer to how much money you will need to retire is not a dollar amount answer at all. Instead, the answer lies within future financial behaviors and decisions. To make this clearer, we focus on the skills and expertise needed to adopt sound, thoughtful financial behaviors during your working years, or the “Accumulation Phase,” as well as in the “Distribution Phase” known as retirement. It is important to remember the goal is not simply to maximize investment returns to out-grow any future financial problems. Rather, the goal is to successfully fund the entirety of your retirement and to confidently enjoy your post-working years with peace of mind.

Accumulation Phase:

The “Accumulation Phase” refers to the period of life most focused on accumulating and growing wealth. These years are typically the “working years” for most individuals. This growth in wealth often comes in the form of a comprehensive investment plan, taking advantage of an employer-sponsored retirement plan, and/or simply budgeting properly to build up cash reserves. Of course, investors do not stop accumulating wealth upon retirement, but the name of this phase of life is reflective of most individuals’ primary objective while working – accumulate and grow wealth. To accumulate the wealth needed for a successful retirement, investors should be competent in the following areas:

• Employer Benefits: Those who receive a benefits package from their employer should be well-versed in the company health insurance coverage, disability benefits, life insurance options, and other health and well-being benefits available to them and their family. Employers are also likely to offer a qualified retirement plan (ex: 401(k), 403(b), Profit-Sharing Plan, Pension, etc.) with provisions to allow for salary deferrals, employer match, profit sharing contributions, and more. Some employers offer non-qualified plans such as Deferred Compensation or Non-Qualified Stock Options that benefit only a certain group or class of employees, so understanding how those operate is important. Self-employed individuals need to be familiar with how to acquire many of these benefits for themselves. A trusted advisor can help craft a benefits package that meets the goals and needs of self-employed individuals and small business owners.
• Cash Flow Management: Proper budgeting and spending management remains a core skill for investors throughout all phases of life. This becomes even more apparent when deciding where and how to save for retirement. We believe investors should be saving 10-15% of their income to meet financial goals later in life. Investors should examine monthly expenses at least annually and adjust as necessary to meet the 10-15% savings goal. Maintaining a proper emergency fund equal to 3-6 months’ worth of expenses inside of a savings account, money market, or equivalent is important to withstand unforeseen emergencies without interrupting your investment plan. When deciding which type of account(s) to save or invest in for future financial goals, we encourage examining three “buckets.” Future tax rates and tax laws are uncertain, so a combination of these three “buckets” is advisable to maintain flexibility to take advantage of current and future tax rates whenever everyone feels they are most favorable.
  
  
  • Taxable | Brokerage Accounts, Certificates of Deposit, Savings Accounts, etc.
  • Tax-Deferred | Traditional IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), 457 plan, etc., and
  • After-Tax/Tax-Free | Roth IRA, Roth 401(k), Roth 403(b), 529 College Savings Plan, Health Savings Account, etc.

• Debt Utilization: Debt, when properly used, can provide powerful leverage to help meet goals. The best example of a “good” use of debt is a home mortgage, provided it is financed responsibly with a competitive interest rate and with annual housing expenses do not exceed 28-30% of gross income. Another example of “good” debt is a business owner financing new equipment or using debt to grow operations. “Bad” debt usually comes in the form of credit cards, personal loans, and auto loans. The most recent data suggests that the average new car payment in the United States is $734/month, and 17% of car owners pay more than $1,000/month. Financing a car is not an inherently “bad” use of debt but financing a car at a relatively high interest rate or with a payment representing more than 5-10% of monthly net income leaves little to no room to save for future goals. In paying off existing debt, liabilities should be prioritized either by smallest-to-largest outstanding balance or highest-to-lowest interest rate. Paying additional principal payments towards the smallest outstanding balance first is called the “Snowball Method” because smaller debts are paid off quickly and momentum is built to payoff larger balances down the road. Paying additional principal payments on highest interest rate debt first is referred to as the “Avalanche Method.” This strategy saves more in interest costs but requires more discipline as it might take longer to pay off the first debt on your list. Keeping up with all minimum monthly payments is required to maintain a positive credit score, thus being treated more favorably when taking on future debt.
• Investment Management: A proper investment plan should consider personal goals, investing time horizon, and risk tolerance. Considering those factors, maintaining an appropriate ratio of growth-oriented investments (ex: stocks, equity index funds, private equity funds) to income-producing investments (ex: corporate bonds, Treasuries, Private Credit Funds, Certificates of Deposit) is critical to sufficiently managing an investment portfolio. For individuals in the Accumulation Phase, growth-oriented investments may be better suited to help reach those future goals. These types of investments typically come with higher volatility, so understanding the balance of risk versus return is crucial. On the other hand, income-producing investments might pay dividends or interest to investors, and typically exhibit lower expected volatility. Continual funding of investments at regular intervals (referred to as “Dollar Cost Averaging”) can be an effective method of building an investment portfolio over time. An easy example of this is a 401(k) or other employer-sponsored retirement plan where an employee defers a portion of their paycheck each pay period to a 401(k), and subsequently purchases additional shares of the chosen investment. Over the course of the employee's working years, they could amass significant growth on monies contributed decades earlier.
• Education Savings: It is no surprise that the rising cost of college education is a major hurdle in younger investors’ financial planning. The national average annual cost for an in-state, four-year, public university is $28,840 (including tuition, on-campus living costs, and related expenses). In 10 years, that cost could reach $51,996 (assuming a 5% education inflation rate). Saving and investing in a tax-advantaged way could provide tremendous support towards a parent reaching their potential goal of funding their child’s education. A 529 College Savings Plan is funded with after-tax contributions, contains a limited fund lineup managed by the 529 plan sponsor, and provides for the tax-free treatment of future growth if monies withdrawn from the plan go towards qualifying education expenses. Uses of a 529 Plan have been expanded in recent years to include K-12 education and trade schools, and the remaining balance that is not used for educational purposes can be rolled over into a Roth IRA in the beneficiary’s name to continue to grow tax-free (with certain annual limitations). For many, student loans remain a necessary source of funding for higher education, so understanding the FAFSA application process and ensuring proper ownership and titling of financial assets is important.
• Estate Planning: During the Accumulation Phase many investors do not yet have the wealth to be concerned with estate taxes or leaving significant assets to heirs. Although those areas could be a larger concern closer to retirement, individuals should still execute basic estate planning to make sure they and their families are covered in the event of a premature demise. Basic estate documents such as a Will, Durable Power of Attorney, Medical Power of Attorney, HIPAA Authorization, and Directives to Physicians (Living Will) are typically sufficient to ensure proper individuals have the authority to carry out your wishes. A Designation of Guardian for Minor Children will be needed for parents with young children. Naming beneficiaries for all financial accounts and insurance policies will ensure that financial assets are passed on to the proper individuals. A Transfer on Death (TOD) or Payable on Death (POD) beneficiary can accomplish the same thing for bank accounts. Deeded real estate can be owned jointly with a spouse (or other party) or owned via a beneficiary deed to provide proper ownership of real estate after death without the expenses of probate.

Distribution Phase:

The “Distribution Phase” refers to the stage of life when individuals are no longer working and must receive distributions from built-up assets to sustain a healthy lifestyle. This phase of life involves an entirely new set of skills compared to the Accumulation Phase. Investments that generate a cash flow might be favored at this time, and the cost of healthcare might be increased with no remaining access to employer-sponsored benefits. Wealth might continue to increase in this phase provided that distributions are not eroding growth in investments each year. To distribute wealth in a proper fashion, individuals must have competence in the following areas:

• Healthcare: If retiring before age 65 and no group health insurance plan is available through a spouse, a retiree is left to either purchase private insurance on their own, pay for COBRA Continuation Coverage of their old group plan, or find alternative means for covering healthcare costs. Upon reaching age 65, retirees may enroll in Medicare Part B, Part D, or a Medicare Supplement plan. Once a retiree reaches age 65 eligibility for enrollment in Medicare Part A is automatic and generally carries no monthly cost, but Part B monthly premiums can vary depending on modified adjusted gross income (MAGI) from two years prior. It is crucial to keep this look-back calculation in mind when deciding to realize capital gains or complete Roth Conversions at or after age 63. Medicare Supplement plans can be purchased to provide for the payment of certain out-of-pocket expenses not covered by Medicare. Retirees must ensure each prescription drug (or a generic version) is covered by their Part D plan, if applicable.
• Longevity Planning: An often-overlooked risk to retirees’ financial planning is the rising cost of care during the final years of life. This is more than just planning for the cost of a nursing home because there are many different types of care that one might need. Retirees should understand the levels of care offered from the less intensive care provided by Adult Day Health Care and In-Home Health Care to the more intensive care required of patients in Assisted Living Facilities, Memory Care Facilities, Skilled Nursing Facilities, and Hospice Facilities. Presently, the national average cost for In-Home Care is $68,640 per year, while Assisted Living Care is $64,200, and Nursing Home is $116,800. The most obvious option for covering these costs is Long-Term Care Insurance. This insurance is typically most cost-effective and practical between ages 55-65. However, if a standalone Long-Term Care Insurance policy is not available, then living benefits via certain annuity policies and life insurance contracts may provide monthly payments to the policyowner to cover these long-term care expenses. You should consult with a trusted advisor before entering an annuity or life insurance contract to understand all the benefits and pitfalls. During the Distribution Phase a life insurance analysis should be completed to determine whether coverage should be reduced, maintained, or increased.
• Cash Flow Management: Just as retirees managed cash flow during working years, it is of equal importance to understand and control cash flow during the Distribution Phase. However, a new set of skills and strategies is required in this facet of planning. Optimizing payments from Social Security and pensions are critical tasks as investors navigate retirement, especially when deciding pension benefits that can continue to the retiree’s spouse upon their own death versus simply choosing the highest monthly payment. Budgeting and controlling expenses remain a large component of retirees’ wealth management in this phase of life, but new or higher allocations of spending for family vacations, charitable gifting, and healthcare may be prevalent. Charitable gifting (and any related taxes) using either cash, investments, or physical assets may impact a retiree’s cash flow, so careful planning should be done to gift in an efficient manner. Required Minimum Distributions (RMD’s) from tax-deferred retirement accounts may result in either too much or too little annual cash flow, so optimizing the proportion of tax-deferred retirement account balances (which have RMD’s) and after-tax retirement accounts (which do not have RMD’s) will be important and is typically covered in a Roth Conversion Analysis.
• Investment Management: The conventional wisdom around managing investments suggests that investors should invest aggressively early in their careers and invest more conservatively nearing retirement. This might suggest a 100/0 (stocks/bonds) investment allocation in your twenties, an 80/20 allocation in your forties, a 60/40 allocation in your sixties, a 40/60 allocation in your eighties, etc. This is an example of an investment “glidepath,” which is a common feature of target date retirement funds. Since individual risk tolerances and investing goals differ from individual to individual, we believe an allocation must be derived from more than just a simple ratio of stocks and bonds. Some investors might also seek to invest in private asset classes, or they might favor investment income over long-term growth, especially in retirement. Rebalancing investments to maintain a proper allocation between asset classes (ex: public stocks, public bonds, private equity, private credit, real estate) is crucial to success, but this action may create adverse capital gains taxes. Additionally, investments that generate taxable interest, ordinary dividends, or short-term capital gains taxed at investors’ ordinary income rates might be better suited for tax-deferred accounts, such as an IRA or 401(k). Investments that generate qualified dividends, long-term capital gains, or tax-free interest are better suited for taxable accounts, such as a brokerage account. Working with a trusted advisor to craft your investment strategy is critical to meeting your goals.
• Tax Planning: Simply accumulating as much wealth as possible with no regard to taxes is not an effective method of retirement planning. The accumulated wealth may be eroded quicker than a slightly lesser amount of wealth that has been optimized to reduce taxes. Yes, there are ways of increasing the longevity of your wealth simply by moving investments, assets, or cash between the different tax “buckets” mentioned previously. The most common method of accomplishing this is through a Roth Conversion, which is the process of moving retirement assets from a tax-deferred account (i.e., Traditional IRA) to an after-tax account (i.e., Roth IRA). The Roth Conversion generates taxable income in the year of conversion, which may have a significant impact on taxes owed and Medicare Part B costs in two years. A careful analysis of all retirement investments should be done to determine the most appropriate years to affect a Roth Conversion, along with the proper amount to convert each year. This analysis should consider the investor’s most recent tax returns and future tax projections, and can be used to understand future Required Minimum Distributions and associated taxes. Using charitable gifting, qualified charitable distributions, certain charitable trusts, and Donor Advised Funds may reduce current-year taxable income or offset some (or all) of the tax implications of effecting a Roth Conversion. Careful planning with a trusted advisor should be done before affecting any of these strategies. Of course, the way a retiree distributes funds from tax-deferred, after-tax, and taxable accounts will also impact their taxes owed, and planning can be done on this strategy to increase the longevity of your wealth.
• Estate Planning: Proper maintenance and updating of the basic estate documents from the Accumulation Phase is imperative, as most families have grown and changed over time. The proper individuals that should carry out your wishes, as well as your named beneficiaries, may change due to death, divorce, adoption or another familial situation. Most people wish to avoid probate, which is the legal process of distributing a deceased person’s assets and settling their debts. Probate is a lengthy, public process that can be very costly, so keeping matters private, avoiding court costs and attorney fees may be a primary goal for many retirees. All retirement accounts and life insurance/annuity policies must have proper and updated beneficiaries, and bank accounts and taxable brokerage accounts should have either a spousal co-owner, Payable on Death (POD) or Transfer on Death (TOD) beneficiary named. Deeded property should either be jointly owned with a spouse, have a beneficiary deed, or placed into a trust. Retirees should ensure their wishes are made known, their documents are stored in a safe but accessible place, and each person named in the legal documents knows the role and responsibility in their estate plan. Proper utilization of revocable and irrevocable trusts is a critical component for estate planning, and each type of trust has different tax implications. There are various types of irrevocable trusts that may provide access to the annual investment income and/or the principal investment to different parties, so careful planning and consideration should be done with a trusted advisor to determine which type of trust (if any) is suitable.

Putting It All Together:

As you can see, asking for a dollar amount answer to the question “how much will I need to retire?” could be a short-sighted or naïve way to approach retirement. A trusted advisor might follow up that question with “how confident do you want to be that you will meet all of your financial goals?” The responsibility of wealth advisors is to:

• Understand your current situation and how you arrived at your current wealth position
• Help you create and define retirement goals
• Craft a comprehensive wealth plan that addresses each of the above areas
• Provide options and context for making retirement decisions
• Help you implement and enact your decisions
• Monitor your plan to ensure you stay on track to meet your goals
  
  

There is a level of confidence associated with each option we present, and our job is to help you decide which option presents the best balance between enjoyment of life and confidence level. Most financial planners or wealth managers have something unique to offer, but the challenge can be finding a trusted advisor that connects with exactly what is needed now and in the future. Good advisors will work hard to prove their trustworthiness, but it is up to the client to accept and reciprocate that trust. Our team believes in meeting a client where they are and implementing plans that instill confidence in decision-making and generate results that meet expectations. We hope everyone takes a step forward in their wealth journey during National Financial Planning month, and we look forward to speaking about how our team can optimize well-being with a trusted advisor in your corner.

If you have questions on either phase, starting your financial plan, or putting it all together, contact one of our advisors today.

Disclaimer: This article is for general informational and educational purposes only and is not intended to constitute legal, tax, accounting, or investment advice. The information, opinions and views contained herein have not been tailored to the investment objectives of any one individual, are current only as of the date hereof and may be subject to change at any time without prior notice. LGT Financial Advisors LLC does not have any obligation to provide revised opinions in the event of changed circumstances. All investment strategies and investments involve risk of loss. Nothing contained in this presentation should be construed as investment advice. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.

Any ideas or strategies discussed herein should not be undertaken by any individual without prior consultation with a financial professional for the purpose of assessing whether the ideas or strategies that are discussed are suitable to you based on your own personal financial objectives, needs and risk tolerance. LGT Financial Advisors LLC expressly disclaims any liability or loss incurred by any person who acts on the information, ideas or strategies discussed herein.