Dennis often tells our team that he and his peers were counselled to plan for a 120-year lifespan when calculating retirement estimates. If you retired at age 65, you had to plan on the money lasting 55 more years. You’d have enough to live on with a hefty margin of error, plus something leftover for your heirs and/or charity.
With stubbornly low interest rates and the high cost of living today, most baby boomers will likely need a much bigger nest egg than they anticipated a decade or more ago. Boomers are reaching age 65 at the rate of 10,000 per day. An entire generation is realizing that their earlier calculations are invalid and re-evaluating their options.
That’s why we’ve built a new tool for calculating how much income your nest egg can provide, based on more realistic data.
Why would you want such a tool? Sometimes investors are surprised by how much money they need to accumulate to meet their income needs after they stop working fulltime. Many made retirement projections in their 40s and 50s, anticipating 6% yields from solid fixed-income investments. When the Federal Reserve began bailing out the banking system, most of those projections became obsolete. This added complexity to the calculations, so few investors have a clear idea about what they should realistically expect from their nest egg.
A Tale of Three Retirements
Before I share our new Retirement Income Calculator, though, let’s look at three different 40-year retirement scenarios. Note that the numbers and charts are meant to illustrate several scenarios, not provide individual guidance. Every person’s situation differs in terms of taxes, time horizons, and other parameters, and we encourage you to work with a financial planner to manage your savings.
Also, the data exclude other sources of retirement income you may have, such as Social Security or a pension. All of the amounts, including annuity incomes, are pre-tax.
Retirement #1: Taking it All at 65
At age 65, you decide to retire with $500,000 in personal savings. You anticipate your expenses will rise approximately 3% annually. Thus, with each subsequent year, you will need to withdraw 3% more than the previous year. You estimate that your savings will grow by 5% annually. You are planning for a 40-year retirement, meaning your savings must last until age 105.
How much money can you withdraw each year, using those assumptions?
For your nest egg to last 40 years, in year one, you can withdraw $17,747, or $1,479 per month, from your $500,000 nest egg. Each year you take out 3% more to keep up with rising expenses.
Follow the yellow line representing your nest egg in the chart above. As you can see, after 40 years your $500,000 is gone.
What happens if you stay within your monthly allowance and live past age 105? Here’s hoping you have generous grandchildren. If not, you might be at the mercy of a Social Security system that may or may not be around in its current form.
There’s good reason the Bureau of Labor Statistics projects that workforce participation for people age 75 and over will rise to 10.5% by 2022, up from 7.6% in 2012. For the 65-74 age group, it projects that the rate will jump to 31.9%, up from 26.8% in 2012 and 20.4% in 2002. Better health and a sustained desire to work may be one reason more seniors are working longer, but another is fear.
As Dennis has mentioned before, 61% of older Americans fear outliving their money more than they fear death. This is a fear we hope no one encounters as they near the end of the line. Other than the late George Burns, I doubt many centenarians are holding down a job.
With that in mind, let’s move on to Scenario 2.
Retirement #2: Adding an Annuity
At age 65, you have the same $500,000 in personal savings that you did in Scenario 1; however, you take $100,000 from your account and buy an annuity. Our go-to source for annuity information, Stan The Annuity Man, says that currently, this annuity would pay $527 for the rest of your life. You use the remaining $400,000 as principal for the next 40 years in the same fashion as in the first case: assuming the same 5% rate of return and an annual 3% withdrawal increase.
Insurance companies have a range of annuities that will pay you for the rest of your life, which our team covered in detail in Annuities De-Mystified. In essence, holding an annuity as part of your overall retirement plan is one way to reduce the risk of running out of money. Since going back to work at 105 is both unappealing and impractical, let’s look at how Scenario 2 plays out.
Your annuity will provide monthly payouts of $527. Using the same 40-year time frame, your monthly income from the remaining $400,000 will be approximately $1,183 per month in first year, for a total of $1,710.
You start out with a bit more money; however, the annuity payment will remain constant, with no adjustment for inflation. At the end of 40 years, your nest egg will be gone, but you will still receive the annuity payments.
There is no way to know how long you will live. Today, a man who reaches age 65 can expect, on average, to live to age 84; a woman, 87. But consider this: one in ten 65-year-olds can expect to live past age 95. Medical advancements are pushing those numbers up, making life after age 105 seem not too far fetched. An annuity is just one way to hedge against running out of money too soon.
One big disadvantage of an annuity is that it doesn’t offer real inflation protection. Even annuities with inflation riders usually yield marginal results.
If you receive Social Security, you can hope the annual inflation adjustments make up some of the difference, but it’s unlikely to be enough to maintain your current lifestyle. That brings us to Scenario 3.
Retirement 3: Delayed Gratification
Instead of retiring at age 65, you work for five extra years and buy a 100,000 annuity at age 70. We will assume you did not add to your savings during that time (though it did earn interest). Many boomers use extra working years to eliminate any lingering debt, so they can retire 100% debt-free. (However, note that we encourage a different approach: using extra working years to save as much as possible, including maximizing catch-up contributions to your 401(k) or IRA.)
If your nest egg grew at a 5% compound rate, it will total $638,141 when you are age 70. So, excluding the $100,000 spent on an annuity, you have $538,141 to draw from. As with Scenarios 1 and 2, we’ll assume the withdrawals last for 40 years here, stretching the retirement period until age 110. Buying the annuity at age 70 instead of age 65 raises your monthly annuity payout to $582 per month.
The lump sum of $538,141 will provide approximately $1,592 per month during the first year. Add the annuity payouts and your total monthly income comes to $2,174, before taxes.
In the first year, your total income, including withdrawals and annuity income, will be $26,085, compared to $17,747 in scenario 1 and $20,516 in scenario 2.And although your savings will still run out after 40 years, you will be 110. By working an additional 5 years and deferring the start date, you get an additional five years before you have to rely on the annuity only.
Calculate Your Personal Projection
This is all a reminder that the best way to enjoy retirement is to build a portfolio that can generate enough capital gains and dividend income to satisfy your spending needs, while leaving the principal intact as long as possible.
Take a look at the Retirement Income Calculator below; it shows the data we used for Retirement #1. You can download this tool, which we used to calculate all three retirements outlined above, here: Retirement Income Calculator.
There are many options for making the most of your nest egg, so you don’t run out of funds when you need them most. Being aware of your financial position is a great start to enjoying your retirement years.
Before I sign off, a quick note on the Money Forever portfolio: on Tuesday we added a new pick to our portfolio’s High-Yield section—one of the largest and most diversified business development companies out there. I was thrilled to share this exciting income opportunity with Money Forever subscribers, and I hope we can start counting you among them. To learn more about this exciting high-dividend payer, subscribe risk-free to Miller’s Money Forever. You’ll gain immediate access to our entire portfolio and our full library of special reports, including The Annuity Guide and The Financial Advisor Guide. Click here to start your 3-month, no-risk trial subscription now.
On the Lighter Side
Dennis mentioned that he and Jo mailed in their ballots this week. Though I’m not voting—I’m a resident of Canada—I certainly understand the sentiment expressed in the cartoon he shared, courtesy of Courtenay W.
Anyone and everyone curious about global politics and its ongoing effects on the resource sector should check out the new book by our colleague Marin Katusa, The Colder War: How the Global Energy Trade Slipped from American’s Grasp. Learn more and pre-order your copy, out November 10, here.
Dennis will be back at the helm next week…