What’s Your Number? By Jeff Brown

What’s Your Number?
By Jeff Brown
New York Times

The question came the other day from an old friend with a one-man business: “What’s your number?” It’s the latest way of asking, “how much money do I need to retire?”
I’ve been asked this many, many times in my years as a personal-finance columnist. I used to take a deep breath, then begin a discourse on pensions, Social Security, life expectancy, plans to pass assets to children, business succession, expected rates of return, inflation … Then, finding that people really wanted a simple, easy answer, I came up with one: “three million dollars.” That’s what you need to retire. No matter who you are, where you live, what your expectations. Trust me.

I like this figure because it’s high enough to force most people to tighten their belts and take investing seriously. But it’s not so out of reach as to make them give up.
My friend’s next question: “Do you include your house in that?”
No. You need a place to live, and your home is not really money in your pocket until you’re ready to downsize or take out a reverse mortgage. It’s the last asset to tap, best kept in reserve in case you live longer than you expect.
So, how do I figure three million?
I follow a basic rule of thumb used by many financial advisers: In retirement, you can withdraw 4 percent of your assets every year. This assumes your investments are returning an average of around 7 percent a year with a mixture of stocks and bonds. A portion of each year’s gains must remain invested to offset inflation, which has run at around 3 percent over the long term. If you had a retirement fund of $1 million, earning $70,000 a year, you would leave $30,000 in the fund and use $40,000 for living expenses. Notice that I haven’t said anything about taxes, which would chew into that $40,000. I figure a lot of people can live on $120,000 a year, before taxes, so that’s how I settle on $3 million total. At first glance, it looks like this approach means living entirely on investment returns and leaving the $3 million intact, to pass to heirs. In fact, it doesn’t. It assumes withdrawals will grow each year to keep pace with inflation. If you live long enough, you’ll eventually invade principal, devouring the entire nest egg in 30 or 35 years. Quicken, the money management and planning software, has a simple retirement calculator for this. If you assume a $3 million next egg at a retirement beginning at 65 and ending at 100, a 7 percent average annual return and 3 percent inflation, you would start drawing on principal in your late 70s. That’s because by then, you’d need to take out more than $200,000 a year to buy what $120,000 buys today. In your 99th year, you’d take out about $416,000, reducing your balance to zero.
After that, well … then it’s time to sell the house. Figuring your real number, of course, takes a bit more work. Start with the things you’re sure of (or fairly sure of), like Social Security. The annual statement that comes a few months before every birthday estimates your benefit if your earnings continue at their recent pace. Assume you can count on $2,000 a month from Social Security. That’s like having a $600,000 nest egg, because $24,000 a year is 4 percent of $600,000. Perhaps you have one or more pensions. Their administrators can tell you how much you’ll get.
With Social Security and most pensions, you can get a bigger monthly benefit by starting benefits later. It pays to figure your break-even point — when the total you will have received by starting later exceeds what you’d have collected by getting a smaller sum for more years if you’d started early. If you think you’ll live past the break-even point, it might pay to postpone the start
of benefits. If you own a business, a slew of additional questions affect your retirement planning. Will you still own the business after you retire or will you cash out? If you keep it, how much will your income drop if you must hire someone to replace you?
Obviously, the big problem with all retirement planning is the unknown. You don’t know what inflation will be or how well your investments will perform. If you use Quicken or another retirement-planning calculator, it’s best to experiment with a variety of inputs for inflation, returns, retirement age and life expectancy. Try to find a range of possibilities that work, neither leaving you with too little to live on nor demanding the unachievable -– because they require sky-high investment returns or monstrous savings.
It seems to me there are two ways to hedge your risk of falling short. The first, as I stress in my investing guide for small-business owners, is to cut spending now, years before retirement, to bolster your annual savings and investments. Cutting your cost of living helps you twice: it gives you more to save now; and, if you will keep the cuts in place after retiring, it reduces the size of the nest egg you require. (This is a subject for another day, but I think most people could retire years earlier simply by keeping their cars for 10 years instead of 5.) Second, think of a fallback retirement plan. Sure, we all like to think of retirement as an endless vacation full of exotic travel, second homes and spoiling the grandchildren. But what’s the minimum you’d need to be happy?
Me? I’d like to fly my little plane to every airport in North America, but with it requiring 10 gallons an hour, I’m not sure that will happen. Give me some bike trails, public tennis courts and a nearby library. … I could live with that.