Q: I’m a single woman in my early 50s who plans to work for another 15-20 years. My main concern is that I’m not sure how much I need to be saving for my retirement. Is there some general rule of thumb I should know for this?
A: Retirement and retirement lifestyles have changed so much in recent years, there really isn’t a one-size-fits-all approach to retirement planning — it’s very personal. Fortunately for you, you still have 15-20 years to properly plan for your specific retirement goals. Here are some of the things you should begin to discuss.
Retirement planning has become an uncertain — and much more stressful — exercise for most Americans. Millions of workers watched their retirement nest eggs decline sharply in value in recent years, and “safe” investments such as money-market investments and CDs have continued to offer relatively low short-term interest rates since then. Aside from current market uncertainties, there are other more constant issues to consider, such as inflation and taxes.
Investors planning for retirement need to begin addressing some important questions well in advance of their actual retirement date: How much will retirement cost? How will I pay for it? How much can I spend each year and not run out of money? Can I plan for retirement while also meeting other financial goals, such as paying off debt?
While it may be necessary to adjust your financial expectations for retirement or even postpone your retirement date, you can still achieve retirement security. But to do so, you’ll want to engage the services of a financial planning expert. Once retained only by the wealthy, financial advisors now assist all types of investors in making decisions about retirement. In fact, perhaps one of the most common reasons for people to begin financial planning is to build a retirement fund.
Countdown to retirement
Have you begun your countdown to retirement? If so, a financial advisor can help you make a successful transition to the next stage of your financial life. Following are some critical areas to address with your advisor a few years before you expect to retire.
— Determine what retirement will cost. Many people enter retirement without the slightest clue as to what they want to do with their time or whether they have enough money to do it. Will you continue to work part time? Travel? Maintain a second residence? Make improvements to your existing home? Be sure you plan how you’ll spend your time because that decision will have a direct impact on how much retirement will cost you.
— Assess your sources of retirement income. Estimate the income and savings you can rely on during retirement. How much will you receive from Social Security, a company pension, a 401(k) plan or other employee-sponsored retirement accounts? Contact the Social Security Administration at www.ssa.gov and/or your employer’s retirement benefits representatives to obtain a report listing the estimated income from these sources. In addition, you’ll want to confirm amounts in other accounts. Do you have retirement assets accumulating in an IRA or a taxable investment account? If your anticipated income does not equal or exceed your projected expenses, develop a plan to bring these two into alignment.
— Arrive at a spending limit. Once you have a handle on expected income and expenses, calculate how much you can withdraw from your accounts each year without spending down your principal. Your advisor can create various withdrawal scenarios based on forecasted investment returns, inflation expectations and other practical financial planning considerations.
Accounting for uncertainty
In the past, calculating annual withdrawal amounts was done by means of simple spreadsheet analysis. A planner would use historical performance averages to project future portfolio values and automatic calculations for variables such as inflation and life expectancy. The problem with such an approach is that the lack of flexibility in the calculations makes it difficult to account for year-by-year variations in outcomes or any unexpected changes in an individual’s life or lifestyle that can affect underlying assumptions.
Fast forward to the present where sophisticated computer forecasting models, such as the Monte Carlo simulation, have become the preferred tools for dealing with the uncertainty around retirement planning. When used in investment decision-making, a Monte Carlo simulation forecasts how a portfolio is likely to perform under thousands of possible scenarios based on a combination of parameters such as life expectancy, interest rates, equity returns and inflation. The simulation is typically modeled around a specific problem (e.g., How much can I accumulate for retirement?). Results are recorded and ordered according to the scenario most likely to meet investors’ retirement goals.
With more attention being paid to retirement planning, forecasting tools based on the Monte Carlo simulation have enjoyed a renewed popularity. In an uncertain world, such tools can help address some of the toughest retirement planning challenges. But remember, any forecasting tool, no matter how sophisticated, cannot predict the future. What’s more, forecasts are hypothetical, do not reflect actual investment results and are not guarantees of future performance. For this reason, you should think of forecasts as a starting point, not as your ultimate planning solution.
This article was prepared with the assistance of Standard & Poor’s Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult a financial advisor or Jeremy Gussick if you have any questions. LPL Financial, Member FINRA/SIPC. *Based on total revenues, as reported in Financial Planning Magazine, June 1996-2010.