People are always asking me, do I have enough to retire? They expect me to be able to look at their 401k statement and give them a “yes” or “no” answer in two seconds flat! The truth is that it doesn’t matter how much money is in your 401k. In my opinion, what matters most are your spending habits. If you can live comfortably on your social security (and pension), then most likely you will have enough to last throughout retirement. However, our culture is a culture of spending:
- we carry credit card balances
- we take loans from our 401k
- we strip equity out of our homes
- we don’t even contribute enough to our 401k to take advantage of the match!
If we can’t live within our means during our career, how do we expect to live within our means during retirement? Who would want to retire to a less extravagant lifestyle? The fact is people expect to maintain the same lifestyle in retirement as when working. If you are a “saver” then you may have lived within your means during your working years, which could mean you have a good shot at a comfortable retirement.
A tale of 2 – Spender vs Saver (to read the rest of this post click the “CONTINUE” button below)
1. Sam the Spender
I was able to put 10% into my 401k plus the match, but cash flow was always tight due to my never ending bills. There was never an emergency fund and there were always credit card bills coming in the mail. I was constantly applying for credit card balance transfer promotions. I have a very nice home, but there is little equity due to the housing collapse and now I’ve just retired with a brand new 30 year mortgage after the latest refinance to lock-in below 6%.
Social Security benefits are enough to pay the mortgage, but that’s about it. In order to pay my other bills, withdrawals from the portfolio are required. Of course, all of my portfolio is in my IRA, because I was not disciplined enough to save any money out of my paycheck besides my 401k. Therefore, each withdrawal is 100% taxable. Wouldn’t it have been nice to have a non-retirement brokerage account that I could be drawing on now without every dollar being taxable? That also would have given me some peace of mind knowing I could have accessed that anytime in an emergency without penalties prior to retirement. I have $500,000 in my IRA, and I need an extra $25,000 per year to maintain my lifestyle. OK, $25,000 is a withdrawal of 5%. In my opinion, a withdrawal rate this high is a red flag – will you outlive your money? But wait! What about taxes? Assuming 25% taxes, I actually need to withdraw $33,333.33 in order to net $25,000. Now I am at a withdrawal rate of 6.6%, in the danger zone. Next the market takes a 20% tumble, and my account falls by 12% to $440,000 (I am in the balanced portfolio). Now that $33,333.33 withdrawal is up to 7.5% and I am panicking.
Will the market rebound and propel my portfolio back to the levels of 500,000?
Is a 7.5% withdrawal rate sustainable? Is 5%?
Should I go back to work part time so I don’t need to draw as much from the portfolio?
Are my bills actually bills or they the result of the extravagant lifestyle I have come to expect?
2. Sandy the Saver
I have been saving 10% in the 401k plus the match. I never carry credit card balances. I use a credit card for all my purchases, but I pay it off every month and I collect dividend “points” from using my card. I carry an emergency fund balance of 6 months expenses in case of a lay off or disability. I fund the maximum into my Roth IRA each year, and have done so since 1998, when the Roth was created. We also have a brokerage account where we invest a couple hundred dollars each month. Finally, we pay extra on our mortgage every month, which reduced the term from 30 to 15 years.
When I retired, our mortgage was paid off and we were entirely debt-free. Social Security pays our big bills – property taxes, insurance, vehicles, etc. We have a portfolio consisting of $500,000 in IRA’s, $50,000 in Roth IRA’s, and $150,000 in our brokerage account. We only need about $1500/mo or $18000 per year to supplement our Social Security to pay for things like entertainment and vacations. We take our withdrawal from our brokerage account, which is subject to capital gains and taxes on interest and dividends. However, much of it is our own principal which comes out tax-free. We are currently taking a withdrawal rate of 2.5% from our portfolio. By the time our brokerage account runs dry, it will be time to take forced Required Minimum Distributions (RMDS’s) from our IRA’s.
Sam and Sandy are both smart people and both earned a good living, but Sam’s lifestyle was more extravagant than Sandy’s, and look at the difference it makes in retirement. Sandy is able to maintain her same level of spending, with less taxes and less worrying when the market volatility is high like it is now – after all, she is only taking out 2.5% of the portfolio.
Main Culprits of excess spending:
- Latte – spending $4 on coffee each day is too much!
- Second home – wouldn’t it be more cost effective to rent during the winter in Florida rather than buy a condo?
- Mortgage – refinance after refinance extends your payments forever. Focus on payoff, not payment.
- Kids – leading up to retirement, it is time to cut the kids loose. No more loans (which will be forgiven). They have 30 more years until retirement, and you are there TODAY.
- Vehicles – If you are only driving a few thousand miles per year, why are you leasing? If you have 3 vehicles, couldn’t you get by on just 2? Each vehicle adds insurance, registration, maintenance, gas, storage, etc.
- Eating Out – isn’t it nice to have a nice dinner at home once in a while?
How do you know if you are spending too much? First simply look at how much you’re earning take-home vs how much you’re spending. I suggest reviewing the last 3 months of bills/payments from your checkbook and create a spreadsheet to track different categories or set yourself up on Microsoft Money or Quicken. Usually a couple items will jump out at you, and it is easy to cut them out.
If you truly are not spending too much, what choices do you have? I tell my clients after your first career is over they should find a hobby they can get paid for. If you love golf, apply at the Pro Shop – this way you get some cash in your pocket, and best of all, free golf! If scrap booking is your hobby, apply at Michael’s – you work with the hobby you love and get a discount on your own purchases. Forget about the Wal-Mart greeter – find a hobby!
Summary:
The answer to the questions “ Do I have enough” does not depend on your account size, it depends on your spending habits. In order to evaluate your spending habits, you must track them either with a spreadsheet or a program like Microsoft Money. If you can’t cut out any expenses, consider finding a hobby you can get paid for.
Nicholas Hopwood is a registered representative with and securities offered through LPL Financial. Member FINRA/SIPC. He can be reached at 734-432-1966 or nick.hopwood@lpl.com