By Massi De Santis
What do you do if your retirement goal seems unachievable? You’ve set a retirement income goal, looked at your accumulated savings, used a retirement income calculator, and find that you are not on track. What can you do next?
If you find yourself asking this question, know you are not alone. While estimates vary across studies, a large number of employees don’t think they are ready for retirement. The good news is that there are a few things you can do to improve your situation. The secret is to rely on levers you can control without taking unnecessary risks.
Set a realistic goal, with the help of a budget
A lot of people start by setting an income goal by using a percentage of pre-retirement gross income, commonly as high as 80% or 90%. This high percentage comes from studies typically done by analysts trying to find good rules-of-thumbs. Trying to find a rule that works across potentially very different people, however, can lead to setting a goal that is simply too high for many or most people.
So my first suggestion is to spend some time budgeting and understanding what your needs and spending goals might be in retirement. A lot of costs go down in retirement. Your kids graduate from college and get a job, your mortgage may be paid off, you may be past your midlife crisis spending, and other expenses may go down too. A key consideration to this calculation is location. Simply moving from a high-cost, high-tax area to a lower-cost lower-tax one can reduce the replacement percentage dramatically. As you go through your budget, you may find additional savings, and discover that your retirement income goal is more in line with your savings than you thought it would be.
Keep in mind that the goal of retirement planning is to best use your lifetime resources. You can decide to spend less pre-retirement (save more) to spend more in retirement, or the other way round. You can’t have both. Budgeting is the first step to help you make this tradeoff. When you are done with it, your replacement rate will likely be lower than 80%.
When would you like to retire?
Realistically, I mean. Start with a desired retirement date, but allow yourself some flexibility. Changing your retirement date is one of the most impactful levers you have when planning for retirement. Delaying retirement by one year means one extra year of savings, one less year of retirement spending, and a likely bump in Social Security benefits. So, start with a desired date, then evaluate the impact of delaying or anticipating retirement by one year, as explained below.
Putting it together with an income projection
After you have a meaningful retirement goal and a realistic retirement date, you can make a retirement income projection using a retirement calculator to help you. Suppose you are 52, have accumulated about $500,000 across your retirement accounts, and would like to retire at age 65. You can save about $1,000 a month and your employer contributes $500 a month to your 401(k) plan. After budgeting, you find that $70,000 pre-tax income would be enough to sustain a comfortable retirement, and you would like to plan until age 90. Your Social Security benefit is estimated to be $28,000 per year. Here are the results from the retirement calculator:
The projected income, including Social Security, falls short of the $70k goal. So now you can use the levers we discussed to improve the odds of achieving your goal. Try retiring at 66, increasing savings by 1% of income per year, or reducing your spending in retirement by 2%. By using all levers, your adjustments are likely to be smaller. This approach does the job in many cases.
Improve the efficiency of your resources
Get as much juice as you can from your given resources, without taking unnecessary risks. Start by using a goals-based approach to your investments. Designing an investment plan based on your goals can help you save more efficiently and improve your long term performance, particularly when you have competing priorities for your savings. Because the composition of your investments regulates how you make a risk-return tradeoff, a goals-based investment plan can help you ensure you have an investment allocation that is appropriate for your capacity and preference for risk.
You should also develop a tax-efficient strategy for retirement. You will likely rely on multiple sources of income in retirement. Social Security, a tax-deferred account like IRAs or 401(k)s, tax-exempt, or Roth accounts, and likely an HSA. Making the right choices when saving, and when withdrawing funds can make a large difference to your sustainable income in retirement, as we discussed before.
Finally, consider whether annuitizing part of your retirement income may be a good idea. For example, if you know you have recurring expenses that exceed your Social Security, partial annuitization may be an effective income option.
Change your investments in pursuit of higher returns?
This last bit is the one that often gets the most attention. Especially in the current low interest rate environment, is there anything we can do with our investments to increase potential returns?
The answer is maybe, but remember that there is no free lunch: Higher returns compensate for higher risk. If not, who would ever accept the lower returns? Yes, interest rates on safe government bonds are historically low right now. But government securities are the safest investment available. So if someone offers you some investment that promises a higher return, there must be a cost, as investors in Auction Rates Securities during the financial crisis may remember.
Increasing the allocation to equities is another way to increase potential returns. But again, that increases the likelihood of low returns as well. The lesson is that you can try to increase potential returns by taking more risk, but you have to have plan B in case your returns fall short of expectations. You have to be ready to make bigger adjustments down the road. That is why we should always start by considering all the other levers first.
Use all your levers
Planning for retirement is making tradeoffs. Most people can’t retire early by saving little and taking no risk. By applying all available levers to your current situation, you are likely to get closer to your goal than you first thought. All it takes is a little planning and the help of a trusted advisor, if you don’t feel comfortable doing this on your own.
About the author: Massi De Santis
Massi De Santis is an Austin, TX fee-only financial planner and founder of DESMO Wealth Advisors, LLC. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow, and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.