By FPA member Jason Branning, CFP®
Last Updated: May 18, 2010
The final descent to the runway often creates a bit of anxiety for many. Do you ever notice your fellow passenger's sense of relief once the plane touches down on the runway? There can be a sense of anxiety until you have touched down and the plane stops. Preparing for and landing in retirement is no different. The same emotions of anxiety are also associated with the transition stage from a working career to retirement.
There are many financial and personal issues that create anxiety for those entering retirement. Perhaps the source of the anxiety is simply that which is unknown. Will I like retirement? Do I have enough money saved? What will my health status be in five years? Are my investments allocated properly? In the case of each individual, the answer is that you and your adviser will never know until the story of your life is written.
While we cannot know the future, developing a retirement plan that can accommodate personal and financial goals requires some creativity and perhaps a bit of compromise too. A qualified financial planner will get to know you and your goals, can help you analyze your goals in light of your financial condition, and can help you develop and monitor a plan that meets your objectives.
Hewitt Associates, a global human resources consulting firm says that individuals will need 15.7 times their final pay including inflation and medical expenses during retirement. Hewitt estimates that Social Security will provide 4.7 of the 15.7. This means individuals would be responsible for saving the remaining 11 times final pay1. For example: $100,000 x 11 = $1,100,000 of assets saved for retirement consumption. Everyone's situation is different and while these figures may be true for some, others need less and still others need more. Are these experts right? What does one need to accumulate for retirement? How much is enough?
The answer to the question of what you need to have saved by retirement is beyond the scope of this article. Instead, let's examine one issue that is at the heart of the question and is universal for retirees. What do I do once my wages stop?
There are various ways of looking at how to calculate what income you need in retirement. One method popularized by Dr. Bruce Palmer at Georgia State University in a research project with Aon2, examines various financial retirement issues. The study reveals one way to arrive at how much income a retiree will need. The income replacement ratio method calculates an income replacement amount by subtracting pre-retirement expenses that will not exist during retirement like pre-retirement savings and pre-retirement taxes3.
One example Dr. Palmer points out is that of a Married Couple (One Wage Earner): Age 65 Worker, Age 62 Spouse4. At $90,000 pre-retirement income, the couple would only need $65,168 post retirement income in order to maintain the same lifestyle, once adjusted downward for things like pre-retirement savings and pre-retirement taxes.
After your adviser has calculated your income needed to maintain your current lifestyle, distribution strategies can be developed. Securing retirement income is a primary concern. Ideally, income should be secure, stable, and sustainable for the retiree's lifetime5. This income, should over time, adjust for inflation and offer some type of back stop associated with it from a government agency, an insurance company, or the Federal Deposit Insurance Corporation (FDIC). The fundamental question in regard to income distribution is, "So, now that my wages have stopped, how can I translate my savings into retirement wages?"
Here are a few questions pre-retirees can contemplate with an adviser:
- How much should I actually replace of my current income?
- How can I securely distribute what I have saved, so that it resembles a paycheck?
- How can I protect my retirement savings?
- When should I take Social Security?
FPA member Jason Branning is a fee-based investment adviser and financial planner with CS Planning Corp. in Ridgeland, Miss. He owns Branning Wealth Management, LLC and serves as a board trustee to FPA of Mississipi.
1 Hewitt Associates, May 3, 2010
2 Dr. Bruce Palmer, 2008 GSU/Aon RETIRE Project Report
3 Replacement Ratio = PrRGP - PrRT - PrRS - WRE +/- NCASE + PoRT
PrRGP = Pre-Retirement Gross Pay / PrRT = Pre-Retirement Taxes / PrRS = Pre-Retirement Savings / WRE = Work-Related Expenses / NCASE = Net Change in Age-Sensitive Expenditures / PoRT = Post-Retirement Taxes
4 Table 1, Dr. Bruce Palmer, 2008 GSU/Aon RETIRE Project Report
5 "Modern Retirement Theory", Journal of Financial Planning's Retirement Distribution Supplement, December 2009. Copyright Jason Branning, CFP®, and M. Ray Grubbs, Ph.D.