The Heart of the Issue: Income
How misunderstood retirement income is and why it is such a problem
Back in the day retirement functioned a bit different. For most they had income from Social Security and a pension that covered most of their living expenses if not all. They had personal savings that either supported their income needs or provided discretionary spending for leisure. Cost of living was low. Home ownership was high. Life expectancy was shorter. It worked really well for about 50 to 60 years.
Today, we have almost the opposite scenario. Social Security at most makes up 40% of income and is declining. Pensions are almost non-existent. Replacement retirement accounts are not income substitutes and very few can or do maximize them. Home ownership is low. Cost of living has risen to being the same as income. People are living a decade or more longer than previous generations.
Herein lies the heart of the issue.
Most people have no idea how income works in retirement. You save in your 401(k) or your IRA and then you retire. Simple. Most financial professionals focus on the time leading up to retirement known as the accumulation phase of life. It is way more fun to talk about growing money, investments, having a nest egg than it is to talk about how much income you can expect to live on.
Retirement is the phase of financial planning known as Distribution. In this phase you strategically spend what you have saved. Before leisure and travel, you need to cover your basics. There you need what I call your “next paycheck” that comes from your retirement savings rather than you working.
Let’s say you have saved $1 million for retirement. Do you know how much income you can expect a year from that for the rest of your life?
$30,000-50,000/year depending on how the market is doing. How does that compare to your current income? That is less than the current median income in the U.S.
This is based on a range of economic philosophies known as the Safe Withdrawal Rate. It calculates how much money you can take out of your accounts and statistically not run out of money. The findings landed on 4%. You can Google “the 4% rule” to find more. If your investments are growing more than you can increase a percent or two. If they are down or earning very low interest, you have to take out less or nothing.
Most planners and certainly none of the popular financial books discuss this aspect much. My hunch is that it is not very fun and maybe doesn’t sell products and services very well. It is precisely this phase of Distribution where we have the largest issue facing the current sub-50/sub-150.
There is a further complicating matter called “future dollars.” This is the idea that you need two “future dollars” for every one dollar you spend today. This is what inflation does to our buying power in the future. Said another way, $50,000 today needs to be $100,000 in the future.
When you start to layer all of these things together you get our situation where the majority of the sub-50/sub-150 will retire at or below poverty level of income. Most will need at least between $1.5-2 million to generate a basic level of income in post-working years.
Here is a calculation you can use to determine what you may need in the future.
Divide your Current Income by 0.04. Then multiply that number by 2.
Example: $50,000/0.04 = $1,250,000. $1,250,000 X 2 = $2,500,000.
That is the amount you need if retirement is 20-30 years in your future to safely withdraw the same level of income you have now.
This creates the present concern around how possible is it for people in the middle class to get to that outcome.
Most of the sub-50/sub-150 are beginning with $100,000 or less saved.
Most of the sub-50/sub-150 are not able to save $30,000/year to get there.
This is why we must begin to treat this with the highest concern so that an entire generation doesn’t enter poverty as they age.