Maybe you’ve seen it referenced in ads. Maybe you’ve read it in articles. Maybe you’ve even heard it from a financial planning professional. There is a notion that everyone has a magical retirement number and “Finding yours today!” is just a matter of an easy, plug-and-play formula.
It’s understandable how folks get caught up in this numbers game, though. Just Google “retirement calculators” and you will have thousands of results, such as this one from younger generation-focused Nerdwallet or this one from AARP. Even industry stalwarts like Vanguard have them.
Outside of calculators, you can also find “expert” hack-type formulas or advice like your retirement income should be about 80% of your final pre-retirement annual income or, as Fidelity outlines, you should aim to save at least “1x your salary by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67.”
This kind of thinking can be dangerous because it keeps you focused on a number instead of the main goal: a recurring income stream that will last as long as you need it. Instead of figuring out what your retirement number is, you really want to look at when you pull what and from where. And there are three main factors that will affect your retirement income stream:
Factor #1: Social Security
Social security is a big game of when. If you decide to start taking your benefits early, your benefits will be reduced for the rest of your life. If you start taking them later, your lifetime benefit amount will be higher for the rest of your life.
But there are a lot of factors to consider. Are you in good health? Are you going to continue working past age 62? If so, then waiting might be best. If you are in poor health or years away from having to take the required minimum distributions (RMDs), you might want to elect to take benefits early so that your investments (IRAs, pensions, etc.) can continue to grow.
Just remember, your social security benefits will still be taxed. But the tax rate will depend on how much other income you have from other sources.
Factor #2: Taxes
Speaking of taxes … it’s important to understand that not all income will be taxed equally. Where you pull your retirement income from will determine the tax liability (if any) that goes with it.
Retirement income falls into three tax categories:
- Taxable: Bank accounts (both checking and savings) and brokerage accounts
- Tax-deferred: Traditional IRAs, traditional 401(k)s, pensions, or other employer plans
- Tax-free: Roth IRAs, Roth 401(k)s, or other Roth employer plans
Most people will want to use their taxable assets (Category 1) first because that allows the money in their other accounts (Categories 2 and 3) to grow bigger for longer, and, therefore, will decrease your tax liability. You’ve already paid taxes on the money in Category 3, so you won’t pay anything once you withdraw those funds. But when you take out money in Category 2 accounts, you will pay regular income taxes instead of capital gains on the appreciated amount. Income taxes are usually higher than capital gains taxes, though. So, knowing when to take withdrawals from each Category will help aid your recurring income stream.
Factor #3: The Market
Take a deep breath, because this one is tough: What is happening with the stock market — something completely out of your control and out of the control of those folks touting that whole “Retirement Number” idea — in the early years of your retirement will be a huge factor in how long your retirement income will last.
This one comes down to the sequence of investment returns and inflation in the first 5-10 years after you retire. Three scenarios are possible:
- The market has several years of negative returns, and your portfolio depletes faster than anyone had planned. This causes you to pinch pennies throughout your retirement.
- The market has several years of positive returns, and your portfolio grows more than anyone had planned. You have more than enough funds for the retirement you always wanted and have even put aside some money for splurges and/or your heirs.
- The market stays relatively flat and your portfolio ends up exactly where you always planned it to be. You get to have the retirement you always planned for but nothing more.
Again, the problem is that no one has a crystal ball and will know what will happen when you retire. Those who end up in Bucket #2 may have to stay in the workforce longer, keep their money invested longer, or both. So the goal is for everyone to strike the delicate balance of having enough of an income stream early on in case of a down market but also enough still in their portfolio should there be a bull market.
Get Uncommon Help
Trying to find that kind of balance for your own portfolio is daunting. Let the experts at Uncommon Cents help. We won’t just give you a magic Retirement Number, we will help you come up with a full financial plan and investment portfolio that includes a predictable retirement stream. Schedule an appointment for a 15 minute introductory call today or find out more about this topic by downloading our eBook!
