Ashland, Oregon countryside
What size portfolio is required for a comfortable retirement? There are numerous variables to consider. Here is an example for our fictitious couple.
We begin with current data on what the average retirement annual salary is and what the average household is living on in the United States. Looking up this data, I found that the average retirement income is $50,200 per year and the average non-retired household is spending $63,036 per year. For ease of calculation for our fictitious couple, let’s assume they need an average income of $60,000. Plug in your own number as an annual retirement income will vary widely depending on where you live in the country. For example, some couples will “require” an income of $80,000 or $100,000.
This example assumes one is either renting or the house is paid off. Regardless of expenses, our retired fictitious couple needs $60,000 annually for living expenses.
And now for a few more assumptions. Where does one derive income in retirement? 1) Social Security. 2) Pensions. 3) A retirement job. 4) Investment income.
In this example I’ll assume no pensions or a retirement job. If one receives a pension, the strain of deriving income from investments is greatly reduced.
An annual income requirement of $60,000 per year translates to $5,000 per month.
- Social Security from spouse #1 = $1,500
- Social Security from spouse #2 = $1,300
Again, fill in your numbers. Our fictitious couple collects $2,800 per month from Social Security leaving a gap of $2,200 per month that needs to be made up from investment income, assuming there is no income from pensions or other income source.
Now we get into some tricky figuring and assumptions. Let’s assume our fictitious couple laid out a saving play years ago so the income thrown off by the portfolio would generate the required $2,200 and they would not need to dip into the corpus of the account to meet this income requirement. This being the case we now come to yet another assumption.
General wisdom dictates one should not draw more then 4.0% from a portfolio so as to maintain a stable amount barring excessive inflation. Conservative advisors recommend no more than 3.0% be withdrawn from the portfolio. My very conservative recommendation is to push that number down to no more than 2% per year be withdrawn from the portfolio. For this example, let’s run out our calculation using the conservative figure of 3.0%
Assume our fictitious couple had the foresight to save or build a portfolio that would throw off a monthly income of $2,200 per month while not withdrawing more than 3.0% from the portfolio per year.
Annual income from the portfolio is 12 x $2,200 or $26,400 per year. That works out to a portfolio of $26,400/0.03 = $880,000. However, it is not all that easy to set up a portfolio that generates an income of 3.0% per year, particularly if one wishes to participate in the growth of the stock market. In case of inflation, one needs to set up a portfolio that will counter rampant inflation. Many of you remember the late 1970s and early 1980s.
The current yield of the Total U.S. Stock Market is 1.3% if we check the yield of VTI. Remember, the fictitious couple does not want to dip into the corpus of their portfolio. This requires another calculation.
Assuming our portfolio yield is something close to the current yield of VTI, we need to work with a much larger portfolio. Here is the bad news.
Our retirement portfolio works out to be $26,400/0.013 = $2,031,000 or over two million dollars.
Couples who pull in money from pensions need to realize just how important that source of income is as pension income relieves the stress on income required from an investment portfolio.
Perhaps an industrious reader will put together a spreadsheet using the above assumptions and share it with ITA readers.
Comments and suggestions are most welcome. Post your ideas and thanks in advance.
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Thanks, Lowell. There are many moving parts to this kind of calculation … rate of inflation, amount needed from retirement (remember there may be one-time withdrawals for things like replacement autos, unexpected healthcare expenses, home repair emergencies, unexpected needs of adult kids or grand kids, etc.), rate of return, etc. But, the calculation should be made using best guesses with all pertinent info at hand. And for those like me who foolishly followed the incorrect advice at the time and did not convert our 401/403/IRA accounts to Roths before retirement, don’t forget to factor in a very hefty income tax bill for the RMDs when calculating retirement savings needs.
Ernie,
I too messed up by not converting 403 (b)(1) accounts to Roth IRA accounts. We are still surviving despite many historical errors.
With taxes about as low as they are likely to be for the foreseeable future, I recommend young folks save as much as possible using Roth IRA accounts.
Lowell
Lowell, I totally agree. I am telling my adult children the same thing. If they can afford to pay the tax now, max out the Roth first rather than the IRA or 401. As I often say, “The good news is we’re in the longest bull market in history and the income tax on the RMDs is killing me, but the bad news is we’re in the longest bull market in history and the income tax on the RMDs is killing me!”
Ernie,
The 401 may have matching funds. Never leave that money on the table.
Paying taxes is a “pleasant” problem in that I would not exchange places with someone whose income is so low they don’t pay federal taxes.
As you are aware, one can reduce RMDs by giving money to charities out of tax deferred accounts.
Lowell
My tax-deferred accounts are all IRAs.
Agree on your take on taxes.
Given the latest tax laws, I don’t have nearly enough income, even with RMDs, to give away enough to get help from my charitable deductions under the standard deduction rule of $27,700 for 2021 (married both over 65). I wish!!!
Ernie,
Perhaps I was not clear. With the current standard deduction rule it no longer makes sense for the average citizen to make contributions out of their checking account. Average means the person is not a major donor.
If one makes charitable contributions out of their IRA account, the RDM tax is lowered. That is the point I was getting at.
Lowell
Ohhh! Yes, of course. Good point. I did that in the past, actually. Thanks for the correction.
Gentlemen:
This issue is a bit more complicated than you indicate. If we assume that income tax rates at RMD time are the same as at deposit time, It makes no difference as to when the taxes are paid. If Tax rates are lower at at RMD time, it pays to defer them; if higher, it’s batter to pay now. I think Ernie’s advice to fund Roth accounts is likely correct in consideration of best a guess for future. The current policies of a planned 2% inflation coupled with the actual policy of printing money at an previously unheard rate leads one to believe that actual inflation will be much higher than 2%. Then, if the huge debt ( more in the last few years + current plans than the adjusted cost of WWII ?) will actually need to be paid, I think we can make a reasonable guess that tax rates will be much higher as well. Our following generations better hope that the MMT folks are correct. Given our currently very low tax rates, my opinion is that one should even now aggressively convert traditional IRA’s to Roth accounts if able to do so.
Len,
You covered all the bases. Most, if not all investors I know are recommending savings in Roth IRA accounts vs. conventional IRA plans. It is a probability position. Taxes are likely to be higher in the future.
The 2nd through 4th sentences of your reply are critical.
Lowell
I would add a caution that the value of Roth accounts is going to create a very tempting issue for the tax folks to attack. I would be surprised if the tax free character is maintained forever.
Len,
That is certainly a chance one takes when going the Roth IRA route. I doubt it will happen as it would certainly create an uproar. Double taxation would not sit well with voters.
Lowell
But, perhaps you remember when SS funds were taxed but once. I expect a similar approach with Roth accounts sometime in future. I don’t think I’m likely to be affected.
Len, the problem with the RMD for me is I have been lucky in the market over the years and am also the recipient of a very modest pension. Because I am debt averse, we only need a small withdrawal of our savings to live on. Given the RMD formulas, I am forced to withdraw more than twice my annual living expenses, forcing me into a higher tax bracket. Last year, e.g., I paid essentially no tax (but I realize there were special COVID features in last year’s tax laws). Of course, if I had done Roth’s all those years I would have considerably less in my Roth portfolio. So, you’re right. It’s complicated and shrouded in the risks imposed by the unknown maneuvers of Congress.
I understand as I am in a similar situation. The fact that all RMD’s have to be distributed before doing conversions complicates the situation as well. I don’t remember the exact date but some years ago during a period when the markets were significantly down, I made a conversion that has been very positive. Now, I am trying to convert as much as I can without creeping too far up the tax brackets as I’m convinced taxes in future are going to noticeably increase and the bracket slope will do likewise. I plan a significant conversion at the next big downturn. Also, as a result of our good fortune, we should remember to use the charitable RMD..