There shouldn’t be any harm in finding ways to simplify retirement planning.
Over the years, much advice has drawn upon “magic” numbers touted as simple guidelines and goal posts for investors. Those cookie-cutter bits of wisdom, however, hardly reflect the changing face of retirement, an evolution charged up by the millions of baby boomers who are just now reaching retirement age. Some of those nuggets may be downright dangerous to swallow.
Here are some commonly touted digits and how they add up:
Magic number: 70%
What it means: Plan to spend 70% of your current income in retirement. For example, if your pre-retirement income is $100,000 a year, you’ll need $70,000 annually in your golden years.
What’s wrong with it: People are living longer than ever. (The life expectancy in the U.S. is 78.4.) With a company pension, you may be set for life, no matter how long you live. But with direct-benefit plans giving way to employee-managed 401k’s and IRAs, retirement savings accounts have become finite, and the risk of running out of money as you grow older is now very real. That is not to say you should live out your remaining days as a penny pincher. But it does mean you need to individualize your game plan.
Do you come from a family with some members who have lived into their 90s? Do you have an illness that may someday require long-term care? Those and other personal factors need to be among the many things to think about as you assess your retirement spending habits and investment strategies.
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Magic number: 4%
What it means: This is another spending guideline. It suggests that a retiree spend an inflation-adjusted 4% of his or her total retirement assets each year, keeping the balance invested with a mix of stocks and bonds.
What’s wrong with it: No less an authority than Nobel laureate William Sharpe, an emeritus professor of finance at the Stanford Graduate School of Business, has written extensively about this “rule” and why it can ultimately be harmful.
The rigidity of the spending plan is among its problems. If a portfolio underperforms, staying the course is a clear path to running out of money. On the other hand, when returns are better than expected, there is an unspent surplus.
Sharpe offers an alternative to the 4% rule: Instead, invest in Treasury inflation-protected securities, or TIPS. If those returns prove insufficient, an investor can always dial up portfolio risk and seek better returns.
Magic number: 62
What it means: This is the earliest age a retiree can start collecting Social Security benefits (at reduced levels). It is also the average retirement age, according to the U.S. Census Bureau.
What’s wrong with it: Working longer doesn’t just allow you to earn full benefits (the threshold for which has crept up to 66 in recent years); a few extra years on the job also means more salary to tuck away and a healthier 401k or individual retirement account.
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