Do we have enough money to retire?

Our resident Retirement Consultant, Jim Otar, answers...

This was the question Rita, my better half, asked me 12 years ago. At first, I told her, “Don’t worry, I am the financial planner in this family, leave it to me”, I continued with confidence, “after all, our former financial planner gave us a forecast in 1992. He was using a 12% average annual growth rate and look how rich we would be according to his plan!”

Then something unexpected happened: I threw away my financial planner’s hat. I found my old engineer’s hat in the attic, dusted it off, and I started researching this as an engineer. I could only find two articles about this topic. The first one was about sustainable withdrawal rates by W. Bengen, a fellow engineer from California. The second was an article called “Retirement Calculator from Hell” by William Bernstein. Anything else, academic or not, was either too tainted by the financial industry, or did not make any engineering sense to me. In 2001, I wrote my first book on this topic, aptly titled “High Expectations and False Dreams”. After reading it, Rita was not amused. Eight years later, I wrote a more comprehensive version, “Unveiling the Retirement Myth”. Rita read only a few pages from it; this time, she was busy getting ready to retire.

“Do we have enough to retire?” There are two aspects to this question: The first part is the cash flow, “how much income is enough each year?” The second part is the assets required: “how much retirement savings do you need at the beginning of retirement to finance your retirement.”

The first part of the question is simple: Add up all your expected annual expenses after you retire. Then, figure out how much income can you expect from various sources: CPP, OAS, GIS, company pensions, rental income, royalties, etc. Take the difference: If your income is larger than your expenses -that would be likely the case if you have government or university pensions- then don’t worry; you have enough to retire. You are in the green zone.

However, if your estimated expenses exceed estimated income then you have a shortfall. To cover this income gap, you need retirement savings. This brings us back to our question “Do we have enough to retire?” To answer this, we need to establish some ground rules.

There are three basic risks for retirement financing:

Longevity risk
Market Risk
Inflation Risk

Longevity risk means the risk of outliving your money. In a retirement plan, make sure that the survival rate is below 10%. Therefore, unless both you and your spouse have a life expectancy five years or less, use age 95 as a minimum age of death to cover the longevity risk properly.

Market risk means adverse market conditions throughout your retirement. The concepts of “time value of fluctuations”, “sequence of returns”, “inflation”, “reverse dollar-cost-averaging” all have devastating effects on portfolio longevity. Make sure that the probability of running out of money at the age of death remains below 10%.

Inflation risk means the necessity to maintain purchasing power throughout retirement. Make sure that the purchasing power does not decline by more than 10% throughout your retirement in your plan.

The final step is to figure out your required savings. For that, find your asset multiplier in the table below. Multiply this with the shortfall (i.e. the income gap) you calculated above. The result is the required savings at the start of your retirement based on actual market history; no assumptions, no forecast, no simulations. If your actual savings are larger than this, you are in the green zone, you have enough to retire. If you have less, then you are likely in the red zone; you need to do one or more of the following to migrate to the green zone: 1. delay retirement, 2. spend less, 3. work part-time during the retirement, 4. rent part of your home, 5. downsize your home, 6. reduce the portfolio costs, 7. stop giving money away, 8. buy a life annuity.

Retirement Age

Asset Multiplier

Finally, as of last month, Rita and I consider ourselves sort of retired.

Jim Otar, CMT, CFP, is a financial planner, a professional engineer, a market technician and a financial writer and the founder of retirementoptimizer.com. His past articles on retirement planning won the CFP Board Article Awards in 2001 and 2002. He is the author of “Unveiling the Retirement Myth – Advanced Retirement Planning based on Market History” and “High Expectation and False Dreams” Your comments are welcome: [email protected]

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