This is article number ten in a series. In this piece I will answer questions 21, 22 and 23 of 32 questions you must answer before deciding when to retire,
- How much income, before and after taxes, will I need from my nest egg?
The answer is a process that is just simple math. Take the total guaranteed before tax income in retirement (usually social security and/or a pension) and have your tax preparer do a hypothetical tax return for you for your first full year of retirement. What is left after federal and state taxes is what you have to spend before you go to your nest egg. Match what is left with your carefully researched and estimated list of after tax expenses in retirement. There is a pretty good chance you will have a deficit (expenses are bigger than income). The dollar amount of that deficit must come from your nest egg on a yearly basis. Now, figure out where and how you are going to get that money from your nest egg (usually from retirement plan accounts). Remember that number is after taxes. Now go back to your tax preparer and have him/her run another hypothetical tax return for the first full year of retirement. However, tell him that the dollars coming from your nest egg have to be NET after taxes. That means you will have to take more than the deficit (the gross amount) that must be taken to pay the taxes involved. The grossed up dollars are what you take from your retirement plan and hopefully withhold the appropriate amount of federal and state taxes as you take the income. Most folks will take the gross number and divide by twelve months to get a steady monthly check in retirement.
- How big does my nest egg have to be to last for my lifetime?
This is a difficult question to answer. If you knew how long you were going to live, it would be easy. You have to guess, and hope you get it right. As an example, let’s assume a $20,000 per year gross withdrawal from your retirement plan nest egg. And let’s forget inflation and investment return just to make the math easier here, but please don’t in your calculations. If your nest egg is $1,000,000 then you run out of money in 50 years and are good to go in retirement. That is the equivalent of taking 2% per year from your nest egg. If your nest egg is $200,000 then the money lasts 10 years and that is taking 10% per year (not good). So, not only do you have to be right about when you die, but also you need to be right about the investment return you will get from your nest egg. This example also assumes that you were correct in estimating that you needed $20,000 per year. If in reality you end up taking $30,000 per year the math changes. The math is simple. The guesses are hard.
- If my nest egg is not big enough, what do I do?
Well you have some choices. You can do some part time work in retirement. You can work longer. You can spend less in retirement, and the fun stuff is usually the first to go. You can also assume that you spend down your capital in your nest egg (not just take interest and dividends). You can get a Reverse Mortgage. You can move in with one of your children. The good news in any of the above solutions, is that you can control all of these choices. Another choice is that you can get more aggressive with your investments. This is not a good idea if you are near retirement, and your hope for return may be unrealistic. This is also something that you can’t control. Not good!
In my next article I will answer the following questions: 24. What do I do about “sequence risk”?; 25. How much do I need in Emergency Reserves?; and 26. Do I want to leave anything for my kids?
If you have a question for me, I can be reached at mike@McNamaraFinancial.com. I promise that I will respond. If you missed any of the previous articles in this series, they can be found at my website McNamaraFinancial.com
Michael J. McNamara Ph.D., CFP®
CERTIFIED FINANCIAL PLANNER™
*Any financial advice in this article is intended to be generic in nature. Readers should consult with their own financial advisors before implementing any advice or suggestions above.