Can you afford to retire?

Several years ago, a KMOX listener came to me for help in planning his retirement. When I asked when he planned to stop working, he replied: “Last Friday!”

“How do you know you can afford to retire?” I asked. He smiled and answered, “That’s why I came to see you!”

These are fundamental retirement planning questions. Can I afford to retire? Do I have enough money saved? As a rule, I encourage folks to get the answers to those questions well before they stop working. Retirement can be a high-stakes, life-changing decision, and you need to be certain that your financial assets and income can support the lifestyle you’ve chosen once the paychecks stop coming.

Let me share three approaches to help you figure it out:

1. Compare your spending needs to your expected income. Calculate the income your investments are currently generating each year: dividends, interest – and source of regular, consistent, and reliable cash flow. To this number add any outside income you expect to receive, such as Social Security, pensions, rental income, etc. Compare this total income figure with what you plan to spend each year in retirement. Can you do what you want to do on the income you expect to receive in the future? And will that income increase over time to keep pace with inflation? The answers to those questions might give you some idea if retirement is feasible.

   
   

2. Use an accepted rule of thumb to estimate what you can afford to spend. You’ve probably heard of the “four-percent rule” that says you can afford to withdraw a little more than 4% of the total value of a diversified investment portfolio during the first year of retirement – and then increase future withdrawals by the rate of inflation. If those planned withdrawals are enough for you to live on – and if you are comfortable with the prospect of systematically liquidating your life’s savings in the process – then you might have enough money to retire.

   
   

3. Put together a real plan. Investment income is nice to have in retirement – especially if it increases faster than your cost of living – but it’s seldom guaranteed. And rules of thumb can serve as helpful shortcuts, but they are no substitute for having a plan in place that considers your true spending needs (including a provision for unexpected expenses). A good plan should take into consideration your financial goals, investment and income resources, your time horizon, and your risk tolerance – at a minimum. From there, the plan can calculate the probability of successfully reaching your goals.

Retiring – like building your dream house – is something most of us would prefer to do only once. You shouldn’t attempt either without a blueprint, because do-overs can be very expensive.

My radio listener, by the way, ended up being very lucky for someone who had failed to plan for retirement. Thankfully, he and his family had worked hard for decades, saved diligently, and invested wisely. That discipline, combined with some sensible spending goals and realistic expectations, has allowed them to live comfortably for many years now without having to worry about money.

But they now have a plan in place for the rest of their lives, and they have periodically reviewed and updated it regularly through the years, to their benefit. And I should know: my team and I created it for them.