Ramona Henderson Pearson wants her family to join an exclusive club with 9 million members: The households in this club have a net worth of at least $1 million. A past president of the National Association of Black Accountants, the married mother of two heads The Pearson Group, a Detroit-based accounting and financial advisory firm. “My goal is to reach $1 million in liquid assets,” says Pearson, 54. “That should be enough for me to retire. I’m hoping to get there in about five years.”
At first blush, $1 million in liquid assets4cash, stocks, bonds, and mutual funds4may sound sufficient to ensure a comfortable retirement. But research shows that even seven figures in savings may fall short of providing retirees with the lifestyle they want. Retirement has changed dramatically in recent years, because Americans are living longer and are healthier and more active. According to the National Center for Health Statistics, African Americans who reach age 65 are expected to live 17.1 more years, and those who reach age 75, can expect another 11.4 years. So if you want your nest egg to help fund two or more decades of leisure and travel, you’ll need to do some careful planning.
First, consider how much you’ll need to maintain your lifestyle. Bill Bengen, a financial planner in El Cajon, California, conducted extensive research in the early ’90s to determine a “safe” withdrawal rate4one that would help ensure that retirees would not outlive their savings. Bengen concluded that a 4% withdrawal rate should be safe. That is, by tapping a portfolio for 4% of its value in the first year of retirement, and increasing that withdrawal rate by 4% each year to keep up with inflation, the portfolio should not run dry before 33 years and might last as long as 50.
Since then, Bengen says he’s altered his views somewhat. “For most of my clients, I recommend an initial withdrawal rate of 4.5% to 5%,” he says. It’s a matter of striking a balance. Some seniors may be able to front-load their withdrawals a bit and spend more conservatively in later life. As you grow older, perhaps past 75, you probably won’t spend as much on travel and other leisure activities as you did during your early retirement years. You’ll need to be prepared, however, for rising healthcare expenses. “If you go much higher,” Bengen says, “say to a 7% initial withdrawal rate, there’s a much greater chance of running out of money while you’re still alive.”
Vicki Brackens, a senior financial planner with MetLife in Syracuse, New York, says it was common in the past for advisers to recommend higher withdrawal rates. But now “people are living longer, so longevity has become a bigger factor in planning for portfolio distributions,” she says. “Greater market volatility also has made me more cautious.” She suggests, therefore, that clients plan on a 4% initial withdrawal rate.
But be sure to look at the numbers: Pearson would withdraw $50,000, or 5%, the first year of retirement; then $52,000 the second year, assuming inflation is 4%, and so on. “That withdrawal rate, in addition to Social Security benefits, should be enough for me,” says Pearson. “If your lifestyle is not overly expensive and your home is paid for, you should be able to live comfortably on that much income.”
With those assumptions, retirement planning becomes a step-by-step process:
1. Determine how much you’ll need to maintain your lifestyle in retirement. Will you spend as much then as you do now? Will you spend more? Less? Several helpful budgeting calculators are available online at blackenterprise.com.
2. Estimate your retirement income from Social Security, a pension, and other sources. The annual statement you receive from the Social Security Administration can help. For a rough estimate of your benefits, use the Social Security quick calculator at www.ssa.gov. “For most employees, Social Security can be counted on to provide no more than 20% to 30% of a working paycheck,” says Steve Cooper, a principal at Nemco Brokerage Inc., an insurance broker in New York City. “If you earn more than $100,000 a year, your Social Security benefits will [constitute] an even smaller percentage of your income.”
3. The difference between the amount of your projected expenses and income is the amount you’ll need from your portfolio. Multiply this amount by 20 to get the target size of your portfolio, assuming a 5% initial withdrawal.
For example, assume your retirement spending goal is $85,000 a year and you expect to receive $20,000 from Social Security. You’d need to withdraw $65,000 from your portfolio each year, so you’d aim for a nest egg of $1.3 million ($65,000 times 20).
So how do you save $1.3 million, or $1 million, or whatever you might need? According to Cooper, saving through an employer-sponsored retirement plan such as a 401(k) should be your first choice. “When you save through your 401(k),” he says, “you save on a pre-tax basis, with 100-cent dollars, rather than the 60-cent or 70-cent dollars you take home each pay period.”
Moreover, you should start as early as possible. “If you wait until the peak of your career4your 40s or
50s4you’ll have to put aside more money to catch up,” says Genevia Gee Fulbright, a certified public accountant in Durham, North Carolina. “On the other hand, you can start putting aside much smaller amounts in your 20s and benefit from a longer time available for the funds to accumulate.”Sophie Beckmann, a financial planning specialist with A.G. Edwards in St. Louis, offers the example of a 25-year-old who puts $3,600 into a 401(k) account. If the same $3,600 is invested each year and the annualized return is 7%, by age 65 the account will hold nearly $720,000. By comparison, someone starting at age 40 and investing that same $3,600 per year would have only $225,000 by age 65. The 15-year head start, during which $54,000 is contributed, generates nearly $500,000 in additional retirement funds.
Starting early may have another advantage if you work for an employer that not only offers a 401(k) but provides a company match and a pension as well. “I’ve been at UPS for 21 years,” says Veronica Floyd, 43, who is now a district controller in Milwaukee. “I started investing in the 401(k) plan when I was in my 20s, before most people are even thinking about retirement. There is a company match, and I contributed enough to get what I considered ‘free money.'” Employees at such companies should contribute at least the percentage that will be matched by their employer. In Floyd’s case, UPS matches dollar-for-dollar the first 3% of employee contributions.
Floyd, too, wants to be a member of the millionaire’s club by the time she retires at age 55. “From the forecasting I’ve done,” she says, “it appears that I’ll meet that goal. With my pension, my 401(k), my Social Security, and my company stock, I think I’ll have nearly as much or maybe even 100% of my current income after I retire.”
Financial Concerns Through the Ages
Builders: Younger than age 35
Reduce your short-term debt
- Credit cards, auto loans
Build savings
- Money market funds, CDs
Acquire insurance
- Medical, disability, car, homeowners, etc.
- Life insurance: 10 times your annual income
Develop a systematic investing plan
- Focus on growth, not income
Providers: Age 35 to 50: Pay children’s expenses
- Private secondary school
- College
- Wedding
Accumulate investments
- Retirement plan
- Supplemental savings plan
- Education fund
Maintain insurance coverage
Independents: Age 50 and Older
Pay down long-term debts: Mortgages, etc.
Review your investment portfolios
- Retirement plan adjustments
Review
medical coverage
Focus on estate planning and long-term care
Source: A.G. Edwards
Withdrawal Pains
How much can you withdraw from your portfolio without running short of money over a long retirement? The following table assumes:
- Investors will withdraw a certain percentage of their portfolios in their first year of retirement.
- The amount of the first-year withdrawal is increased by 4% a year. That’s roughly the inflation rate over the past 30 years.
- The stocks and bonds in the sample portfolios earn their historic averages: 9.8% and 5.8% per year, respectively.
Depending on your portfolio mix and your first-year withdrawal rate, here are the chances you’ll be able to maintain this income stream over a 30-year retirement. As you can see, if you want to start with a 5% draw, you should keep at least half your portfolio in stock4and live with stock market volatility throughout your retirement.
Source: A.G. Edwards
| Â | Stock/Bond Mix | ||||
| Â | 100/0 | 75/25 | 50/50 | 25/75 | 0/100 |
| Withdrawl Rate | Success Rate | Â | Â | Â | Â |
| 3% | 93% | 96% | 98% | 98% | 91% |
| 4% | 84 | 87 | 88 | 84 | 62 |
| 5% | 72 | 74 | 70 | 53 | 29 |
| 6% | 60 | 57 | 46 | 27 | 10 |
| 7% | 47 | 41 | 26 | 11 | 3 |
| 8% | 35 | 27 | 14 | 3 | 1 |