Selecting the right advisor for your financial situation can be a somewhat daunting task. It is important that the individual you select is not only qualified, but qualified in your specific area of need. Like many professionals, financial advisors are often specialists in explicit areas of interest.
Many financial experts recommend planning on 70% to 80% of your pre-retirement income to pay for your living expenses in retirement. That is always a good general response but may not have much to do with your situation and needs. It is a little more complicated than that. Very few, soon to be retired clients tell me that can live on 70% of what they were earning a few weeks ago. This is especially true if most of the source of their retirement income will be taxable. In many cases, just having enough inflation protected income to pay for the basic essentials…food, healthcare, taxes, housing, transportation and clothing can be quite a challenge. I believe a target of 90% to 100% replacement is more realistic.
How will you know when your nest egg is big enough? Some of us remember from high school algebra, (in between naps) that we use facts we know to solve for the unknown. If you know how much retirement income you will receive from other sources like Social Security, or any employer pension plans you may have earned a benefit in, you can determine the amount of income you will need to fill the income gap that may prevent you from retirement. So… all you need to do is take an amount from your savings to fill that gap. Don’t we wish it was that simple!
If you have been a diligent saver and have eliminated most of your debt you may be able to withdraw 3% of your nest egg each year and retire comfortably. However, you may need to withdraw 4%, 5% or even as much as 6% per year to fill your income gap. Is it possible to withdraw the higher amounts and not run out of money? This is when solving for the unknown can be a real challenge. How long will you live? How will your investment portfolio perform? What about inflation? Will your expenses be more or less as you age?
A common tool used often by the financial industry is the Monte Carlo analysis. Too bad this tool is named after a famous gambling site, but since there is no guarantee of success, just the possibility of success based on repeated simulations and a number of assumptions, it may be appropriate. It will only provide you with a range of possibilities. For example, in a 30 year retirement period, a 4% initial withdrawal from a portfolio of 60% stocks and 40% bonds will have an 89% chance that you will have enough to cover the entire 30 year period. That means there is an 11% chance you will fall short. If your income gap requires a 5% withdrawal from the same portfolio mix, you will have a 68% chance of success. This means you have a 32% chance of failure. And if you need to withdraw 6% from your nest egg….forget about it! Your success rate falls to 42%.
Unfortunately the question of how much you can withdraw from your account and have enough is not a simple project. By working with your financial advisor you should become more comfortable with this challenge and be better equipped to make the best decision possible. While this may be your first experience dealing with retirement distribution issues, the right financial advisor should have years of experience in these situations during their career. The first big decision you must make is to find the right financial advisor for your situation.
Coming next:
Finding the right Financial Advisor
Having enough money and protecting it from market volaility has become one of the big challenges of retirement planning. Dramatic increases in life expectancy over the last several decades has made it increasingly important to guard against the risk of outliving your assets. It is critical to protect assets that will be needed thoughout your retirement.
Americans continue to enjoy ever-increasing longevity as we adopt healthier life styles and take advantage of improvements in health care. According to the Society of Actuaries 2000 U.S. Annuity Table the probability of survival to age 85 for a female currently age 65 is 62.2% and 49.3% for a male. For at least one member of a couple surviving to at least age 85 there is a 80.8% chance !
Steep stock market drops can be great opportunities for the young since they are able to buy low and let their investments grow for many years. When you are about to retire this same market decline can make withdrawals damaging to your plan for spreading your available assets over your lifetime. Dollar cost averaging, the tool that worked so well while you were accumulating assets in your 401(k) is of little use when you are spending down your assets in a volitile market.
Just as you were getting the hang of properly diversifying your portfolio during accumulation, you must now consider a new strategy to successfully manage your assets over your lifetime. Take too much out and you may outlive your assets. Take too little and you may miss out on the retirement experience you have worked so hard to enjoy.
Comming next……How much can I take out ?
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