# Week 7: Financial Planning Concepts

Course Progress:

“Someone’s sitting in the shade today because someone planted a tree a long time ago.” ― Warren Buffett

When will you have enough savings to retire?

This is an interesting question, for at least two reasons. First, as you approach retirement, it’s something you’ll need to know.

Second, because of life’s inherent uncertainties, you can never know for sure, unless you’ve got so much money you can’t possibly spend it all.

I’ve been asked the “Will I have enough?” question many times over the years. It’s one reason I put this course together.

Here’s an answer I published to this question. It offers a quick, back-of-the-napkin way of knowing whether you’ll have enough.

## How Do I Know I’ll Have Enough to Retire?

Approaching retirement and wondering if you have enough saved? Here’s a simple, quick method to find out.

Today’s question is about retirement; specifically, how to know when you’ll have enough savings to ensure a comfortable, happy retirement. It comes from Jane.

“I’m confused. I plan on retiring in about five years, but have absolutely no idea whether I’ll have enough. Is there any way to be sure?”

This is a question we’ll all face sooner or later. Here’s a super-simple method of figuring out whether you’ll have enough.

##### Step one: Add up what you have

You know what you have in the bank, your retirement plans and any other accounts you have. Add them together.

Will you continue contributing the same amount to your savings between now and the day you retire? If so, total all those monthly contributions and add that in. Now you’ve got the total you’ll have to work with when you retire.

Divide your total savings by your life expectancy. Example: You’re going to retire at 65 and, based on the math above, you’ll have a total of \$200,000 in savings. Your life expectancy at 65 is 20 years. Divide \$200,000 by 20 years and there you have it: \$10,000 a year.

That’s a very rough estimate of how much annual income your savings will generate, providing you’re willing to spend down your principal. Add to that your Social Security, pensions and any other income, and you’ll have an idea of how much you’ll be living on.

Saving too much is never a problem; not saving enough definitely is.

Keep in mind that you could add to your savings. Maybe you’re planning to sell your house and downsize. Or, you’ll be inheriting. Or, maybe you’ll work part-time in retirement. But at least you’ve got a quick, back-of-the-envelope way to estimate what you can count on.

Some will say, “Wait a minute! Aren’t my savings going to be earning anything while I’m retired?” Sure, but you’ve also got inflation to take into account.

So, for a quick, down-and-dirty computation, let inflation and interest cancel each other out. Simply take what you’ll have in savings, divide it by your life expectancy, add what you’ll get from other sources, and you’ve got a quick number to work with.

##### Step 2: Figure how much you need

If you don’t know how much you’re spending now, this is a great time to figure it out. Use a budgeting app or simply write down everything you spend until you have a handle on it.

All things being equal, you’re not going to need as much income in retirement as you’re spending now. When working, you have costs like payroll taxes, commuting and buying clothes you probably won’t need in retirement.

On the other hand, depending on how you intend to spend your retirement years, you could be spending more than you are now. Either way, confront your future.

These two exercises give you an exceedingly simple look at your likely income and expenses in retirement. You can — and should — drill down a little more. In Week 3, we listed some online calculators that can help. Now, at least you’ve got a starting point.

##### Step 3: Don’t stop there

When approaching retirement, many people bury their heads in the sand. They’re afraid they’re not going to have enough and don’t want to confront it. So, they don’t do anything.

Dumb idea. Do something.

While most of us are experienced in socking away whatever we can, few of us have given much thought to something equally important: converting those savings into a regular monthly income.

Don’t wait until retirement to find you don’t have enough. Plan now, when you have options. Maybe you can put away more, get a side job and make more money, or think about where you might live for less when you retire.

The sooner you start confronting your retirement reality, the better off you’re going to be.

So, there’s a two-minute way to see if you’ll have enough. But it’s not the best way.

As I wrote, it assumes you’ll spend down your savings to zero, which means you need to die on the day the actuarial tables say you will, leaving nothing for your heirs. Also, it assumes your savings won’t beat the inflation rate, which I hope will not be the case.

### Retirement calculators

A better way to determine if you’ll have enough money is to use one of many online calculators, like this one from SmartAsset, this one from Bankrate or this one from AARP. There’s also a good series of online worksheets on this page of the Department of Labor website.

These calculators ask you things like:

• At what age you intend to retire
• How much you regularly save
• How much you have in savings now
• The rate of return you expect from your savings
• How much you expect your income to increase before retirement
• The percentage of your current income you’ll need in retirement
• How many years you expect to live in retirement

While calculators can be helpful, as you read through the list of inputs they require, you’ll see why I’m no fan of depending on online calculators.

These calculators require answers you can’t be certain of. For example, do you save the same amount every year? I don’t. Do you know how much your income will increase over the next decade? Not likely. I’m self-employed, so I don’t know what I’ll earn next month, much less for the next 10 years.

How are you supposed to know the percentage you’ll earn on your savings from now until the day you die? Nobody knows where interest rates, or stocks, are headed. If I had that crystal ball, I wouldn’t have any use for a retirement calculator. Then, of course, there’s the biggie: When are you going to die?

That’s why, although retirement calculators offer some degree of insight, and are the best tool available, they don’t produce perfect results.

### What’s the solution?

First, think about ways you might want to spend your retirement years and try to put a price tag on them. Next, get a handle on your daily expenses by using a spending plan, both now and continuing into retirement. Third, use whatever tools there are, like calculators, to at least get a rough estimate of what you’ll have.

And last, but definitely not least, save as much as you can for as long as you can. After all, saving too much is never a problem; not saving enough definitely is.

As retirement approaches, sharpen your pencil and use the proven techniques below, so your money can last as long as possible.

### Generating income from your retirement assets

If my family had a spirit animal, it would have been a squirrel.

Both children of the Great Depression, my parents preached never allowing winter to approach without a lot of nut-gathering. And gather nuts they did.

Though neither of my parents made big incomes while working, they died with a healthy monthly income and big bank accounts, and even had enough food squirreled away in the pantry and freezer to last a year.

As you might guess, I inherited their thrifty ways. I’ve literally spent my entire adult life offering advice on how to make more and spend less, and practiced what I preached. I’m now so tight I squeak when I walk. And I’ve stored enough nuts to last many winters.

These days I’m approaching a different phase of my life, and so are you. Winter’s coming. It’s time to create a system to ration our stash of nuts so they last a lifetime.

While most of us are experienced in socking away whatever we can, few of us have given much thought to something equally important: converting those savings into a regular monthly income.

There are several ways to approach generating a regular income from your retirement assets. A few of the most popular:

• Try to live on Social Security and whatever additional monthly income you’ll receive, only tapping your retirement savings in an emergency.
• Convert part or all of your savings into a regular monthly income by purchasing an annuity.
• Systematically withdraw a fixed amount from retirement savings. Four percent annually is a traditional number.
• Use Social Security for your fixed monthly expenses, like rent and food, and your retirement savings for the extras, like travel.

### Which method is best?

In 2017, the Stanford Center on Longevity and the Society of Actuaries explored 292 different retirement income strategies to determine the best approach and produced a study, titled “Optimizing Retirement Income by Integrating Retirement Plans, IRAs, and Home Equity: A framework for evaluating retirement income decisions.”

One study author, Steve Vernon, summarized it in an excellent paper, “How to ‘Pensionize’ Any IRA or 401(k) Plan.”

These reports are fairly complex. Here’s a summary:

### Social Security rocks

One of the most important conclusions was that Social Security is the perfect retirement income generator. Here’s why:

• You can use strategies to increase it. (More on that shortly.)
• It’s at least partially tax-free.
• It lasts for life.
• It increases with inflation.
• Unlike investments like stocks, it can’t decrease in value.
• It offers a survivor benefit.
• It’s maintenance-free; no specialized knowledge needed.

As you can see, especially when compared with riskier or high-maintenance tools like a 401(k) or other investment account, Social Security is hard to beat. Therefore, the study concludes, your priority should be to get as much Social Security as possible.

How do we do this? Let’s count the ways.

### Procrastination pays

The simplest way to get more Social Security is to do what few Americans do: Put off claiming it for as long as you can afford to — and that varies from person to person.

You can start Social Security benefits any time between 62 and 70. But the longer you wait, the more you get each month.

Example: Say your monthly benefit at your full retirement age, typically 66, is \$1,000. If you start taking benefits at 62, your monthly check will be 25 percent less — \$750 instead of \$1,000. But if you wait until 70 — when you get the maximum payout — you’ll get 32 percent more: \$1,320 monthly.

Despite the obvious advantage of waiting, more than half of Americans claim benefits early. In fact, the Social Security Administration says, more than a third start benefits at 62. Fewer than 4 percent wait until 70.

There are legitimate reasons to take Social Security early. I wrote an article on this topic called “Should I Wait to Take Social Security?”:

Many people may not be able to wait because they need the money. Or, they may simply feel like retiring at 62. In other words, a lot of people want their money as soon as they can get it.

I’ll most likely wait until 70 because I’ll probably work until then and won’t need the money. My family history would suggest I’ll live a long life. My job — typing on this computer — isn’t too physically demanding. So, while I can’t know for sure, it’s likely I can wait until 70 and enjoy those fatter checks for many years thereafter.

That’s me. It may not be you.

A few years ago, one of my best friends asked if he should take his pension early, and I said, “Hell, yes.” Why? Because he wasn’t in great shape, health-wise. Both of his parents died young, his siblings died young, and he desperately needed the money. So, my advice to him was, “Take it as soon as you can get it.”

I gave his eulogy one year later.

Tip

Bottom line: The reason you’ll often hear people like me say it’s a great idea to wait is simply because you’re going to get more money by waiting. But don’t think there’s a single right answer to this question.

### 70 is the new 65

The expression above was coined by Steve Vernon in the paper I mentioned earlier, “How to ‘Pensionize’ Any IRA or 401(k) Plan.”

According to the National Center for Health Statistics, just 100 years ago, men could only expect to live until around age 50, on average; today that number is closing in on 80. So, back in the day, people worked until they were at death’s door. They certainly didn’t spend decades in retirement.

While making 70 your new retirement age may not sound appealing, it’s not unreasonable, especially if you, like me, enjoy what you do and have some degree of flexibility in how often you do it.

In short, one way to avoid collecting your Social Security until age 70 is simply to work enough to support yourself until you’re 70, achieving the maximum possible benefit. After that, use your Social Security as the foundation of your retirement income.

Tip

This isn’t a “66 or 70” choice. Waiting until age 70 will win you the maximum additional income, but every year you delay after your full retirement age to claim Social Security results in 8 percent more lifetime income.

### What if you don’t work that long?

Another way to quit working before 70 but delay taking Social Security is what Vernon calls a “Retirement Transition Bucket” system. You set up an account from which you’ll pay your living expenses from whatever age you choose to retire until age 70. Use a stable, no-risk account, like a money market fund.

Vernon suggests one more idea — the SS/RMD Strategy. Here’s how it works.

While working, most savers use a pre-tax retirement plan — an IRA, a 401(k) or a nonprofit 403(b).

A Roth plan receives after-tax contributions, so you pull money out tax-free. But if you contribute pre-tax money, the government eventually wants its pound of flesh. The way that happens is by requiring you to take money out of your pre-tax retirement plan, and pay taxes on it, starting no later than April 1 following the year you reach age 70.

Other plans receive pre-tax contributions, and you’re eventually required to take some money out and pay tax on it. That’s a Required Minimum Distribution, or RMD. It’s determined by a life expectancy table.

For example, when you reach 70 ½, your life expectancy is estimated by the table to be 27.4 years. That means you’re required to take about 1/27th of your balance, or 3.65 percent, from your retirement account. The next year, your life expectancy is 26.4 years, so you’ll be required to remove 1/26th, or 3.8 percent of your balance.

Your RMD percentage increases as you age and continues until you’ve either drained the account or died.

The SS/RMD Strategy accelerates your RMDs. Instead of waiting till 70 ½ to take distributions, you start withdrawing from your retirement account after you stop working, and use those withdrawals to support yourself until age 70. Then, file for Social Security and enjoy a higher benefit for life.

Keep in mind that while you obviously want to withdraw as little as possible to support yourself until age 70, you’re not limited by the RMD percentages. After the age of 59 ½, you can take out as much as you want. (You will, however, have to pay taxes on withdrawals from a non-Roth account.)

###### Read: “Confused by Retirement Accounts? Roth, Regular IRAs and 401(k)s Made Simple”

One disadvantage of this approach: You’re shifting resources from a liquid resource to an illiquid one. In other words, you can take a lump sum of cash from your retirement plan should the need arise, but you can’t from Social Security.

A potential drawback: When you get your projected Social Security benefits online at the Social Security Administration’s site, they assume that if you take your benefits at 70, you’ll work and contribute to Social Security until then.

The simplest way to get more Social Security is to do what few Americans do: Put off drawing it for as long as you can afford to.

Since you’re not working until 70, you won’t be contributing for those years. This strategy may reduce your Social Security payments. But, depending on your earnings record, the impact probably will be small.

Bottom line: Every year after your full retirement age that you delay taking benefits grows your Social Security payments by 8 percent — for life.

If you’re only earning 2 percent in your 401(k), you could easily be better off using that money now and having a 8 percent higher lifetime benefit later.

Once you reach 70 and achieve the highest possible Social Security payments, you’ll supplement your Social Security income with the required minimum distributions from the remaining assets in your retirement plans.

It’s likely you won’t even have to compute those withdrawals: Many 401(k) and IRA plan administrators will figure it out for you and mail you a check annually. But it’s good to estimate so you can set your expectations.