When would you like to retire? At 65? 55? 45? Well, depending on your answer and how old you are now, you can calculate how much you have to save and invest each month to create an acceptable passive income stream in retirement. If you can figure out how much you need to save and invest and where you need to save and invest then you can eventually become financially independent enough to retire! However, if you miscalculate or don’t follow through with your plan, you run the real risk of outliving your retirement income stream.
Planning for Retirement
You see, life before retirement is like walking up a mountain. The longer time you spend walking up this proverbial mountain, the more time you have to make, save up and invest your money. Yet at some point, we are going to want to come back down the mountain safely, which means we are going to want to stop having to work for money. As we walk down the mountain, we will want to have all the money we saved and invested work for us. Of course, if you didn’t plan right on the way up the mountain before you got to the peak, you might not make it all the way back down, which means you run out of money in old age.
If this happens, then you won’t be alone: one third of all seniors in the US are economically insecure. This means that they have incomes within 200% of the Federal Poverty Level. This statistic is borne out by the research done by the Elder Index showing that older adults need $1,000 more each month than the average Social Security retirement benefit, which was $1,670 per month in January of 2023.
To avoid becoming a statistic later in life, you need to make sure you pack your bags well before you continue on your journey towards the peak of the mountain (ie: retirement). You can do this by planning out how much money you want to withdraw every year of your retirement from your savings and investments. The earlier in life you start planning this, the better the results. A cherished few people start to plan for their retirement very early in their working life — and these people can expect greater financial security and a bigger passive income in their golden years.
From Pensions to 401k Accounts
Planning for retirement for many people was easier back in the day. Back then, a lot of people had company pensions that paid a good chunk of their salary to them in retirement for the rest of their lives.
This system worked well because pension plans automatically took money from your salary, invested that money for you, then paid it back to you as guaranteed retirement income for the rest of your life. But the heydays of pensions didn’t last forever. In the 1980s, saving/investment accounts like IRAs, 401k’s and 403b’s quickly became the norm. Unlike pensions, where your employer would set the amounts that employees paid into the plan automatically, these accounts allow you to choose how much you’d like to contribute with each paycheck.
These savings and investment accounts help you to go up the mountain during your work life, but there are no guarantees that you’ll make it back down in retirement without outliving your money. By themselves, these plans don’t create a retirement income stream. You might be asking at this point, how much money you would need in the typical investment/savings plan to avoid running out of money in retirement. Well, financial researchers are recommending that based on current longevity rates, that we withdraw no more than 4% of the money each year from our nest egg. That means living off of about $40,000 a year for every $1,000,000 in nest egg money — I think most of us would agree that’s a pretty low amount!
“Planning for retirement for many people was easier back in the day … [when] a lot of people had company pensions that paid a good chunk of their salary to them in retirement for the rest of their lives.”
Living off of 4% of your savings and investment is problematic enough, but add inflation to the mix and the task of having financial security in retirement seems hard to achieve for many. At just 3% inflation, for you to have the spending power of $100,000 of today’s money would need $180,000 20 years from now. To safely withdraw that much as 4% per year, you will need a nest egg of a little less than $5 million in investments and savings by retirement time. If you run your own retirement numbers, how much money will you likely have at retirement and how much will you have to live off of with a safe withdrawal rate of 4% per year?
Safely Increasing The Withdrawal Rate in Retirement
How does that number sound to you? Would you want more money in retirement? Would you need more? You see, the challenge that many of us face is not so much that we don’t save and invest enough during our working lives, but that we stand to run out of money in retirement if we take out more than a modest 4% a year. But ask yourself, what if there was a better way? What if there was a better strategy you could use to withdraw 7%-13% of your nest egg per year in retirement without having to worry about outliving your money? That means that for every $1,000,000 you could potentially create $70,000 to $130,000 a year of passive retirement income.
Two Solutions
Now how can we do this? One way to do this is to optimize your income streams in retirement using a combination of cash, investments and whole life insurance that builds up a cash value over time. The earlier in life you set up your plan, the better the benefits you can get from repositioning your whole life insurance, savings and investments. Once you retire, you can access money from your cash savings and investments on a monthly or quarterly basis during years when your market investments are performing well. However, when your investments are not doing so well, you can leave your money invested and instead take a policy loan from your whole life insurance. This way, you avoid exiting your investments when the market is down but instead you use your life insurance’s cash value as a volatility buffer during those years. Using this method typically allows retirees to have a withdrawal rate of between 7% and 13% depending on market performance.
A second method that allows people to withdraw more than 4% annually in retirement involves the careful use of annuities as well as whole life insurance. Particularly effective for couples who have each built up their net worth in separate qualified investment accounts over their lifetime, this method involves rolling a suitable amount of each account into an annuity and covering the lifestyle of the surviving half of the couple with the death benefit of the other half. Using this method typically allows retirees to have a withdrawal rate in the region of 8%. The advantage of this method is that your retirement income is contractually guaranteed by an insurance company rather than dependent on market returns.
With either method, careful planning around tax liabilities, investment mix and configuration of the life insurance policies is absolutely necessary in order to optimize the withdrawal rate. Note that in any case, only the income from annuities and whole life insurance policies can be guaranteed. Remember, money invested in the market can always lose or gain value.
Finding Your Guide
Finding a good guide is the first step in the process of creating a solid retirement plan. When it comes to retirement planning, I work with savers early in their careers as well as other pre-retirees and retirees to manage and protect their assets. One advantage of working with me is that my services are free to my clients – I am paid by the financial institutions I work with so that you do not ever have to pay me directly to receive a comprehensive financial plan. Another benefit is that I represent a wide range of financial institutions and can provide options from different providers.
If you are looking for a sound financial plan for you, your family or your business, reach out to me today by calling (305) 613-1498, via my contact form or by booking a consultation directly into my calendar.