Finalizing Your Plan
This means you’ll need $2,052 in the second year,
and so on and so on... Examine the year chart below (split into two
images as its width doesn’t fit on most screens in one snapshot):
Notice the user above cannot even buy new bonds each
year, because (s)he immediately needs to withdraw from their nest egg more and
more each year to live comfortably.
It is clear that the questionable role of inflation can
make safe retirement planning a rather sticky ordeal.
In the above example, the retiree begins in Jan. of 2004
with $600,000 in bonds paying an average of 5.28% tax free and has $16,000 worth
of additional income after taxes. His/her total annual income-in-pocket is
computed roughly at $47,200 with inflation costs at $40,000 and non-inflation
(mortgage) costs at $10,000.
Immediately, there is a small deficit which grows each year
with inflation as (s) he needs to pull more money out each year to
compensate--which, in the case of bonds, is next-to-impossible since bonds are
typically sold in $5000 to $10,000 increments and there may be loss incurred for
selling early and withdrawing if market interest rates have increased since the
date of purchase.
Plugging your own numbers into a similarly-designed
spreadsheet should help you determine precisely how much you’ll need to retire
IF inflation averages 3.1% in a way no other plan can.
The user of the sheet above, for example, can replace the
January 2004 “Amount in Bonds” number (which is presently $600,000) with any
other trial number and spreadsheet software will automatically calculate the
rest of the figures accordingly. As (s)he raises the $600,000 starting number to
$700,000...$800,000 etc;-- (s)he will find a point in the spreadsheet where the
income will consistently stay above the cost of living-- that point represents
the amount (s) he will probably need to retire safely.
The first time you devise such a spreadsheet, you may be
surprised to find that a few years down the road-- you not only need to withdraw
from the nest egg--but that you start running into negative numbers--i.e. you
run completely out of money.
You’ve simply found out that you may need more money
saved than you thought to retire comfortably--and safely--planning for
Notice that the chart above tells the user how much more
they’ll need to re-invest in new bonds each year to keep up -- based on a
hoped/expected rate of return of 5.28% with inflation averaging 3.1%. The only
time it might be considered “safe” to have to withdraw from the nest egg is
if the spreadsheet suggests that those withdrawals aren’t necessary until say,
20 years down the line--and most of the initial bonds purchased have approximate
20 year maturity dates.
Extra caution would then need to be taken to time bond
maturities along with the need for cash. The
younger you plan to be when you retire, the more such an option is available to
you. Otherwise, it might best to either a) not invest at all (or leave money in
minimal money market-type investment) and withdraw annually from your nest egg
if there’s enough to support a comfortable lifestyle and account for inflation
or b) plan to save enough such that you can live comfortably off the income from
tax-free municipal bonds while having enough left over to re-invest in more
bonds each year--enough to stay ahead of inflation.
The key to devising your own spreadsheet is as follows:
Column 1 (Year), Column 2 (Amount Saved), Column 3 (Amount
of Income Generated From Savings [[Multiply Column 2 Value by 6% or any
reasonable value]]), Column 4 (Miscellaneous Income), Column 5 (Total Income
[[Value of Column 3 and 4 added]]), Column 6 (Your Inflationable Costs [[For
subsequent rows take this value and increase by 3.1%--being careful to program
your spreadsheet to add 3.1% each year to the immediately preceding year]]),
Column 7 (Non-Inflationable Costs), Column 8 (New Bonds Needed [To keep up w/
your rate of inflation, add 3.1% to the value present in the
inflationable costs field and multiply the difference between the two
numbers by the appropriate figure. If, for example, you’re working with a
5.28% expected annual yield from bonds then the formula would look like this:
Because you would need 3.1% of the present inflation need--
and multiply it by 18.93 to find out how large a bond you’d need to purchase
such that 5.28% of its value will equal the difference/raise/increase you need
in the following year.
The next column simply adds the result of the previous
column to the total amount needed for the year --and Columns 10 and 11 are
customized to deal with whether there is any shortage or overage in the amount
that needs to be re-invested to fulfill the requirements of the plan.
In closing, we leave you with some well-intentioned words
from our web site:
[Remember that] the best route to any destination is typically plotted with a
map of some sort. Similarly, the surest way to achieve any goal is to follow a
carefully conceived plan for doing so. Unfortunately, too many people retire
with only a rough idea of how much they'll need, of how much their lifestyles
will cost in years to come, and of what sort of "backups" they'll have
if one or more elements of their strategy fails.
Often, these same retirees rely on the loose investment
counsel of financial planners without fully understanding their logic. Even if
you're not the "driver" behind the wheel of your plan, it certainly
helps if you personally know the best roads to take, the directions to follow,
and what alternate routes to pursue if traffic becomes unmanageable.
As you study our guide, ask questions, and pre-plan your
retirement before meeting with a planner-- you will be surprised just how much
more you have to offer the conversation.
You might even find that your advisor is “not for you”
and be motivated to interview others. Plan carefully....and be thorough.
wish you all best wishes in your retirement. Please contact us if you have any
questions or you need help in planning.