Navigating the Retirement Risk Zone

How much money do you actually need in order to retire? So this is a complicated question for most of us to answer and and more so because if you go online and you do some quick searches about how much do I need in order to retire at any age, you're gonna find a lot of different competing information that give you random multiples of portfolio assets. The truth is this is actually a pretty simple number to calculate, but it is very individual. So we're gonna show you today in this video the simple math framework you'd use in order to calculate how much you'd need in saved assets in order to retire. And then you can use this information to both create a savings target so you can meet that level of assets if you're still saving or make a good decision about when to retire knowing how much you have saved and how much you'll need to draw an income from that savings with this formula.

So stay tuned. We'll do an example for a individual and for a couple, and, we'll go right into it. So if you're new here to the channel, welcome. My name is Eric. I am the owner and head financial planner at Peak Financial Planning.

And we help people like you navigate the retirement risk zone. Alright. So to identify your retirement number, you'll need 3 data points. The first thing you'll need to do is to determine or estimate your retirement spending. Now there's a couple ways to do that, and we'll get into that in a second here.

But once you can estimate your retirement spending, we'll then be able to backtrack how much of that spending will need to be covered by portfolio income or income generated by your saved assets. We like to call that portfolio kickoff. Now for most people, they will have multiple income sources in retirement. You won't only be covering your expenses through your saved assets. And so, therefore, using any type of mathematical model that only relies on estimating income from saved assets will be incorrect.

So once we have part 1 and part 2 there, then we're gonna need to make some kind of assumption about your estimated, length of life. That's pretty difficult. There's no real standard way to do this. In a couple seconds here, we'll go through each of these components. And as I said, show some examples.

The idea here is hopefully you can watch this video, understand how to do the simple math that goes into these little problems here, and then make your own assumptions that are comfortable for you so that you can make wise decisions about how much to save, when to retire, and then how to construct your portfolio income. So the first elevate here is to have an estimate of your retirement spending or your desired spending in retirement. There's a lot of ways to skin this cap. I, at peak financial planning, tend to lean towards the most detailed approach because, you know, you only retire once. And if you retire twice, it hasn't been a success.

And that means that your retirement plan has blown up. And the entire retirement planning process is extremely sensitive to spending for most of us. So if we are not diligent and specific about our spending, we're gonna run the risk of making changes to our lifestyle on the assumption that the plan might work out when in fact it might not if we're off on our expenses. But I'll give a couple different methods for how to calculate expenses and leave that to you to make a decision about what you feel most competent and most comfortable doing. So the first and simplest way to calculate expenses is to take an estimate of your current expenses if you're not retired and then multiply that by you know, 85%, so 0.85 or 0.9.

You can just take those expenses, assume that they're gonna go down slightly at the point you retire because you might have things like you will no longer be saving for your retirement once you are retired. You might also have your house paid off once you're retired. Or you might have kids that move out of the house that you're currently supporting, and that expense level will go down. So using some kind of a current day expense level, and then multiplying that by a factor can be a useful tool. Another thing you can do is your take home income.

If you're preretire, maybe you're a couple years out of retirement, 3 or 4 or 5, take that income and then multiply it by a factor as well, and then reduce that, in order to come to some kind of estimate. Now, the more detailed approach that I favor is to actually have some kind of a budget. Now, I'm not talking about a budget where you set limits on your current day spending. I'm just talking about sitting down or using some kind of template to then fill in the actual numbers on things you spent in current day and then going through them as a list and eliminating or reducing the ones that you know will get eliminated or reduced at the point at which you retire. It's the most detailed approach.

The last and final method you could use, which would kind of piggyback on that, is you could use a budgeting tool like an EveryDollar or a Mint, something that pulls transactions in and actually categorizes them for you, presents you the data in a more readable format, and then you can go through that and just double check and make some small adjustments to plan for your future spending in retirement. Step number 2 here is to use that estimate of spending to then generate a number for your required portfolio income or what we call portfolio kickoff. And the way you're gonna do that is you'd first make a list of the income sources you will have in retirement separate from your portfolio. And for most people, they'll have some combination, at least one of, if not a few, of Social Security income for themselves and or a spouse if you're married, pension, annuity income, part time income from part time work, maybe rental property income, or maybe some passive income from other investments like limited partnerships. What you'll wanna do is start by taking those and making an estimate of those.

So let and one second here, we'll get an example. But what we'll do then is with that estimate of other sources of income, I like to call these guaranteed sources of income. They're income sources that you don't need to you don't need to, support through your portfolio. So, you'll make a total or a tally of those sources of income, and then you'll take your desired amount of spending, net the 2, so subtract your income and your spending. And whatever the balance that's left there is is what you need to support through your portfolio.

We call that portfolio income, required portfolio income. And then with that required portfolio income, we can now make an estimate of how much we'll need in saved assets. The way we'll do that is we have to take part 3 here, which is make an estimate of how long we will live in retirement. Now, the standard estimate in retirement planning is somewhere around 30 years, but you can make your own estimate depending on you might know your family health history and know your own personal health at a level that's better than I could through this video. And so you'll use your own estimate.

But the standard estimate is something like 30 years. And if we did that and we said, hey, 30 years of portfolio income required, we could then backtrack the number. I'll show you the math in a second here. Alright. So let's do a couple examples of this calculation.

So let's start with the individual. Let's say this individual wants to spend $65,000 per year in retirement. Their income sources are Social Security income of $28100 per month and rental income of $725 per month. Combine those together, and we end up with a yearly total income of $42,300 from sources that are not related to portfolio. So we can do our quick math here.

65,000 in spending or desired spending, less the 42,300 of income. And we have a resulting required portfolio income of $22,700. So now we need to make some kind of assumption for length of life. In this case, we'll use the standard financial planning estimate, which is 30 years. So we'll take that 227100, multiply that by 30, and we end up with $681,000.

So that would be the individual's baseline required portfolio, so that they could survive for 30 years in retirement with flat level spending of 22,700. Let's do it in a couple as well. It's very similar, but, you know, the only difference you might have in a couple or the standard difference is the social security that your spouse might have. So let's say a couple wants to spend 95,000 in retirement, and they have, social security income from 1 partner of 3,000 a month, from the 2nd partner of 1500 a month. And then one of the spouses has a pension of 1300 a month.

So their combined household annual income would be a little higher in this case, and that would be at $69,600 per year. So now we can backtrack the amount that they need for from their portfolio, which is 95,000 less the 69,600. And that results in a required portfolio income of $26,600 in order to, maintain that standard of living. Again, we'll use the standard financial planning estimate of 30 years of life, multiply the portfolio income by the 30 year requirement, and we end up with a required baseline portfolio of $781,000 Now I'm sure you have been as I was doing those math models, you are thinking the same thing I'm thinking, which is, well, there's some flaws there. And the true that is true.

One thing we have not accounted for there is inflation. So in that math model we just talked about, we're thinking that you would spend a level even amount of 20 ish $1,000 in either scenario for the rest of retirement. Well, what happens if cost of living goes up over time? You know, over 30 years, it is highly likely cost of living will go up by a significant amount. We would need to include an inflation factor in there.

Now for this, you might want a financial calculator or an Excel spreadsheet, but you could run a very similar model. You get that year 1 required portfolio income. You add an inflation factor. It'll tell you a total lump sum you need if you're going to increase your spending, let's say, by 3% per year. Pretty easy math, also super useful.

But one of the reasons that this model we use, the simple model, is useful is because it can give you a baseline, a baseline number of your saved portfolio or your required portfolio assets. You know that without inflation, you need around 790,000 for that couple scenario and around 680,000 for that individual scenario. Well, you know that's the minimum you'd need, not accounting for inflation. So it can just give you a target on the bottom line. The second, issue here that we might wanna address is what happens if I live longer than expected?

Might I wanna include some kind of an asset buffer or a savings buffer if I live longer than 30 years? And then the third issue here that we wanna address is sequence of returns, which refers to what happens if there are bad market years and I draw money from my portfolio. What is the consequence of that and how do I plan for that? Do I reduce my withdrawal? Do I get a job?

What what do I do? How do I plan in advance for that? Can I do I have to save more? Now I have entirely, a video dedicated to sequence of returns risk. And if you click on that video up above in a second here, you can watch that.

I highly recommend it. That is one of the most influential risk factors retirees will face, and it is well worth planning for and understanding in advance. One final item of consideration as we bring this video to a close is that your required portfolio income is useful as an estimate to help you create a retirement deadline, like when you wanna retire and understand how much you need in saved assets, but it is a moving target. And that is why financial planning should be an ongoing and collaborative process because your spending needs change year by year. Inflation rates might change year to year.

Your health will change year to year. And so all those things need to be factored in, and that makes this a dynamic process where we might have to adjust savings rates or spending rates at different years in order to maintain the longevity of your portfolio assets. Now that doesn't mean it's not helpful to do a model like this. In fact, it really is. You need baseline numbers of what to shoot for as far as savings in order to make a good decision about retirement, but the case still remains that you should think of this as a dynamic process.

So once again, I'm Eric with Peak Financial Planning. Thank you for your time and attention watching this video. If you'd like to learn more about this topic or other retirement related topics, you can find a ton of videos on our YouTube channel. Or if you'd like to learn more about the process we take our clients through when we're planning for their retirement, you can go to our website at www.thepeakfp.com to learn more. There's also a whole bunch of links in the description to this video that can link you to a webinar we do, other information on our website.

So please feel free to check those out. And as always, submit some comments or questions in the description or in the comments section below and we'll be sure to attend to them. Thank you so much for your time and attention and see you in the next video.