Have you done the math?


September 9, 2020

My Dear Reader,

In talking with numerous prospects over time, I often run into the same questions over and over.  Will I have enough? Have I saved enough? Or even the statement about how much they want to receive in retirement.  I have begun to wonder if we in the financial industry are truly going over this crucial step in the planning process.  

Whenever I first meet with someone, I always ask them these three questions:

  1. Is it one of your goals to make more each and every year that you’re working?
  2. If you could, would you want to retire at the same amount of income that you’re making now?
  3. Do you think taxes are going up, down, or staying the same over your lifetime?

In asking these questions, I hear all kinds of responses, except for the second one.  Most people have gotten used to living with the income that they achieved, and that’s a good thing. Shouldn’t we in the financial industry be focused on improving or at least maintaining the standard of living of the people that meet with us? We’ve been over how the declining real rate and its relation to bond yields, and in the bigger picture this means that the monte Carlo theory has to be adjusted.  Remember, the monte Carlo theory is a baseline for the rate that one can draw from their qualified plan.  Currently, this rate is hovering between 3 and a half and 2 and a half percent. This means that to achieve an income of at least $29,000 per year, those who have invested in qualified plans have to reach a minimum $1,000,000 nest egg.  But let’s use an example of an average income earner who wants to stay at that level in retirement.

To calculate this, we’ll first determine how many years that this individual will be working.  In this case, we are going to assume that a 22-year-old will start a job at 50,000 and never change in salary until he retires at age 65. This means that in retirement he’ll want to earn 50,000 per year.  Using the 2.9% monte Carlo theory, we’ll divide 50,000 by .029 and come to the answer that this individual will need to earn about 1,700,000 in a qualified account to generate 50,000 in retirement. In order to achieve this number, and assuming that he puts in 6% of his yearly income into his 401k, he’ll need to earn a rate of return every year of 15.96%.

This is assuming that there is no inflation, and we are not factoring in social security, though that would be taxed in retirement given this individual’s income. A well-managed 401k should earn an average of 8%.  When we start to factor in social security, taxation, and inflation, the needed rate of return continues to rise just to combat these known factors and only gets worse if we account for market corrections.

To your Creation and Potential,

Kevin Prendiville