Lazy Man and Money

How Much Money Do I Need to Retire?

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That’s the title of the book that Todd Tresidder gave me at Fincon 13. I was so excited to read it that I churned through it on the flight home. Many months later, I am finally putting together the book review. That’s how busy I’ve been with the new baby. Let’s hope my memory is good enough to do the book justice.

At first glance, the book’s size and scope reminded me of Mike Piper’s Can I Retire? Piper’s book is 100 pages, and Tresidder’s is 120 including appendixes and his biography. This book is part of his “60 Minute Financial Solutions” series. I think it takes more than 60 minutes to really digest How Much Money Do I Need to Retire, but I’m a slow thorough reader and I was focusing intently on the details in order to write the review.

How Much Money Do I Need to Retire? is quite different from Piper’s Can I Retire?. While Piper concentrates on investments, Tresidder’s approach is more concept-oriented. In particular, Tresidder seems to advocate an unconventional approach that I’ve written about in my early retirement plan posts. I’ll get into more details in that later.

How Much Money Do I Need to Retire? is divided into three parts or retirement models. However, in reading the book, it felt that there really are two distinct models. These models serve as blueprints for building a successful retirement plan.

The first model is conventional retirement planning. If you are a regular reader of personal finance, you most likely know what this is. The idea is to get a big nest egg of cash and draw from it, typically using the rule of 4%. Tresidder points out a number of problems with this method. The biggest problems center around having to make guesses at things you can’t possibly know. For example, it is really hard to know what your expenses are going to be when you retire. Who knows what the cost of health care will be? As you get closer, it becomes easier, but from a distance, it is very much a crap shoot. The same is true with investment performance. Even if you retire at 65, you might need that money to last another 20 years. What’s the rate of the return of investments going to be over that time? What if you live another 35 years instead of 20?

There are so many variables and any one of them can drastically alter any retirement plan. Even that 4% rule is coming under question. A small difference there makes a big deal in figuring how big of a nest egg you’ll need. Tresidder does a much, much more thorough job of explaining this in the book.

Another alternative model is to use a cash flow model for retirement. Essentially the idea is to have enough money coming in from various sources to pay for your lifestyle. The money could be coming from dividends, interest, annuities, Social Security, income producing real estate, or royalties (for those in such fields). It can even be a business (or hobby business) that you can run somewhat passively or that you truly enjoy. If you have enough of these forms of income, you don’t really need a big nest egg (granted you’ll need a nest egg for dividends and interest, but not the others).

Sometimes it pays to be smarter and not rely so much on the terrible interest rates that banks are giving and put more emphasis on Lending Club where I’m getting closer to 7%. I’m not saying you should put $100,000 in there, but if you were to have similar returns, you could use that to passively earn around $7,000 a year (of which inflation would eat away some). If your bank is paying you close to 1% then you’ll earn $1,000 a year (and inflation would likely put you at a loss). It’s a big difference.

The other half of the coin is matching your lifestyle to fit this cash flow model. Keeping expenses down just a little makes a huge difference in one’s ability to reach financial independence. You don’t have to live his minimalist lifestyle, but if you are able to find happiness in the things money can’t buy, you should be able to keep expenses down.

If your cash flow income passes your expenses… guess what? You can pretty much retire. You want to make sure that you are prepared for emergencies, but for the most part you don’t need to have that big nest egg. You don’t need to worry if the 4% rule will hold up. You don’t need to worry about that burn rate.

Over the years, I’ve gravitated to this cash flow way of thinking about retirement. That isn’t to say that we don’t have 401(k)s and IRAs and we are still building up that nest egg. We are taking a hybrid approach that I will go into more in tomorrow’s post.

Not to sound like the Dos Equis guy, but I don’t recommend a lot of books, when I do I’ll be recommending How Much Money Do I Need to Retire?

How to Figure Your Retirement Needs

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Many of us look forward to retirement. However, as with all things in life, retirement requires money. This means that you need to determine how much money will be required to live your desired lifestyle. As you do your best to figure out how much you need, here are some hints for getting a reasonable idea of what to expect:

What Does Retirement Mean to You?

The first step is deciding what retirement means to you. The “traditional” definition of retirement involves working until you are somewhere between 55 and 65 years old and then quitting to live off money amassed in your nest egg.

For many, though, retirement means something else. It might mean starting a side business and building it so you can leave the rat race at age 40. Perhaps it means building passive income streams so that you can become a digital nomad, traveling the world. And maybe it means quitting your job at 50 and traveling around to visit your grandkids while you live off your nest egg.

Everyone is different, and you need to figure out your own definition of retirement before you start turning to online resources that can help you with the next steps in your retirement journey.

Estimate Your Retirement Expenses

Once you know what you expect to do in retirement, it’s time to estimate your retirement expenses. I like to start by looking at my current expenses. This gives me a rough idea of what to expect in retirement, since the reality is that my expenses will not decrease (the old rule of thumb states that you can live off 75 percent of your current income in retirement); they will just be different.

List out your necessities, and then list out your wants. If you plan to travel a lot, that’s going to be a big expense added to your retirement costs, if you aren’t careful. This is a good time to plan out how you’ll make it happen. Travel costs can be significantly reduced if you make a “home base” for a month or more, and choose your destinations carefully. From food to utilities to housing to hobbies, estimate what it will cost you to live during retirement.

You can also attempt to figure out likely health care costs and the impact inflation is will have on your expenses. These are costs that many people leave out when performing calculations, but they can cut in to your quality of life when they aren’t accounted for.

It seems like a lot to figure out, but it makes sense to sit down and do it. Most Americans haven’t taken the time to perform a retirement needs calculation, and that can put them behind, since they might not be saving enough. There are plenty of online resources and retirement planning apps that can aid you in this process, and if all else fails, a fee-only financial planner that specializes in retirement planning can help you with a one-time assessment that can put you on the right path.

If you haven’t determined your retirement needs yet, there is no better time than now.

Are Reverse Mortgages a Good Plan for Retirement?

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The following is guest post from Zillow.com’s Jay Robert. I’ve written before how useful I’ve found Zillow in estimating the value of my condos, especially because they have a lot of similar properties to crunch the numbers on.

Reverse mortgages seem compelling, allowing older homeowners to convert the equity they’ve built in their homes into cash. But is a reverse mortgage a good plan for retirement?

What Is a Reverse Mortgage?

First, it’s important for homeowners to understand how a reverse mortgage works. With a traditional mortgage, a homeowner pays the lender monthly payments until the home is owned outright. In a reverse mortgage, the lender pays the homeowner either a lump sum, monthly payments or extends the homeowner a line of credit, but when the borrower dies or sells the home, the loan must be repaid in full. The amount of money the lender pays the homeowner is based on the value of the home, the interest rates and the homeowner’s age, which must be at least 62. Many older homeowners use reverse mortgages for income during retirement while benefiting from living in their homes.

Foreseeable Benefits:

A reverse mortgage may provide much-needed income for homeowners who haven’t saved enough for a comfortable retirement. As long as the property is appreciating in value and the homeowner borrows only a reasonable sum, the mortgage can be a good option. Even if the home depreciates in value and the sale of the home does not cover the amount of the loan, the homeowner or the heirs are not responsible for any overage. The homeowner’s heirs must pay back the borrowed funds and cover the lender’s fees upon the homeowner’s death if they wish to keep the property, but that sum may be manageable if the loan is conservative. Typically, heirs sell the home to cover the costs owed to the lender, with any surplus going back to the estate. Borrowing from a lender should always be a thoughtful decision, especially with reverse mortgages obtained later in life, when the burden to repay may affect the amount of the owner’s estate.

Potential Drawbacks:

Reverse mortgages are expensive. Fees apply for loan origination, appraisal, title insurance and other closing costs. These charges sometimes cost double or triple the fees associated with traditional mortgages. These fees are usually rolled into the cost of the loan.

Homeowners with reverse mortgages typically have less to leave their heirs because they are removing equity from their homes. Heirs are left with the burden of selling the home or repaying the loan and fees in full to take ownership of the home. Additionally, homeowners are still responsible for paying the property taxes, insurance, maintenance, utilities and other expenses associated with their properties or risk losing the homes.

Alternatives:

Homeowners should consider all of the alternatives before opting for expensive loans that can burden their family members. Consider selling the home to buy a less expensive residence, and apply the remaining funds toward retirement. Homeowners might decide to continue working for a few more years to save for retirement or pick up a part-time job for extra income.

If homeowners decide to go with reverse mortgages after considering the benefits, drawbacks and alternatives, they should shop around as the costs of reverse mortgages vary widely. Read the fine print in order to understand the terms and conditions of the loan, and discuss the plan to repay the loan with the beneficiaries of the estate.

 

Your 401K is Costing You $155,000!?!?

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Did that catch your attention? Good it should have.

I missed this article last June in NBC News, Your family is probably losing $155K from 401(k) plan, and why new rules won’t help. (And I thought I used long titles.)

The $155,000 comes from this study by Demos. The culprit? Investing fees.

As the NBC News article points out, “Doing the math to determine real investing costs from fees is tricky. It involves a long series of assumptions on factors so individualized that no 401(k) projection model is easily generalized. Instead, the Demos study and others like it are merely ‘for instance …’ examples.” To be fair to Demos, they did their best to create and average couple: people earning average income, contributing the average amount to a 401k, having average growth, over an average 40 year career, etc..

So that’s where the “probably” comes from in the NBC article. No one really knows how much the investing fees are going to cost you and everyone is different. However, even conservative estimates from Wall Street sources in that article pin it at $20,000.

This infographic from MoneyNing on 401k fees gives some examples from various companies of the best and the worst. The best 401k plan comes from GE at a price of $45,998, while the worst is Avery Dennison at a whopping $355,057 in fees over a career. That Avery Dennison total covers more than 5 years of the example employee’s salary. (Side Note: If you clicked through and wondered why I didn’t include the very lowest number in the infographic it is because it incorrectly categorizes the military’s Thrift Savings Plan (TSP) as a 401k . It is essentially the same for the participants, but technically it is different. The TSP is one of the better military perks with a miniscule $6,674 fee in the example.)

While there’s a huge difference between $355,057, $155,000, and $20,000, none of the numbers should be of consolation to the average person.

Why?

We, Americans on average, don’t have that much in our 401k accounts. The NBC article quoted Fidelity as saying that the average person has $75,000 in their 401k and that those close to retirement have an average of $100,000. The Center for Retirement Research two years ago pinned it at $149,400. As I discovered last year even People Making a Lot of Money Still Don’t Have Enough to Retire. That article pointed out that those who make in the 75th percentile only have a median of $52,000 in their retirement accounts (all retirement accounts, not just 401ks)… and those people age 50+ who had time to save .

However you slice and dice the numbers the fees, even at the lowest estimates are very significant compared to the savings.

So what can you do about the investing fees? The answer is not much.

Most 401ks have limited options and people are locked into choosing high fee fund vs. high fee fund. Perhaps I’m being a little too harsh on the fund fees. I should say that the fees are less than optimal. If you had the ability to invest the money however you wanted to, you could choose some very low fee Vanguard funds… often with a cost of 1/10th of a percent a year. In contrast, 401ks can average around 1% in fees. That probably doesn’t sound like much, but years of investment compounding make that number mean a lot.

The two actions I recommend are:

  • Look for funds with low expense ratios in your 401k. Typically these are index funds rather than managed ones.
  • When you leave your job, you’ll will probably have the opportunity to rollover your 401k into an IRA. Do it, because then you’ll be able to choose options with low fees.

If there’s one thing I don’t recommend, it’s waiting to contribute to your 401k. You don’t have to be median if you are contributing a big number consistently. My guess is that many people are put off investing in their 401ks because they’ve got other financial priorities going on (maybe paying off credit card bills) or aren’t living within their means. You are also not a “for instance”, and do have some ability to limit the impact.

Contributions to my 401k have been one of my most power weapons in my fight for financial freedom.

People Making a Lot of Money Still Don’t Have Enough to Retire

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I have a friend who knows a lot of people who make extremely good incomes. We are talking well into the 6 figures. She has noted that more than once they are living paycheck to paycheck. It reminds me a little of this story of getting by on $1,000,000 a year. It has been easy for me to dismiss this as just anecdotal stories, not evidence of any kind of trend.

However, analysis from SCEPA (Schwartz Center for Economic Policy Analysis) says even the highest earners don’t have enough retirement savings. While that’s not the same as saying that they live check to check, it is noteworthy.

The research looked at people in the 50-64 age range and divided them into four groups based on income. They found that 75% of the people have annual incomes below $52,201 and an average retirement account balance of $26,395.

I know you are probably saying, “Hey these aren’t the people making a lot of money. You are pulling a fast one on us Lazy Man.” You caught me. I’ll get to the top 25%ers rather than the bottom 75%ers in a minute. I took you on a detour because I found it particularly interesting that there’s going to be a large percentage of the population in “near retirement” on what amounts to about 18 and a half months of maxed-out 401K contributions. I put “near retirement” in quotes because that’s what the study considered those in the 50-64 age group.

So let’s get back to the top 25% earners. These are people making more than $52,001 a year. They have an average retirement account savings of $105,012. While that is certainly a lot better than the $26,395 of the 75%ers, it represents just slightly more than two years of annual income… The study also showed that 50% of these people (sorry to go heavy of statistics) have retirement account balances of $52,000 or below, so this is another 12.5% of the population that’s really on the light side of savings.

I should note that the people making $52,000, while in the top 75 percentile, are not those making six or seven figures like I mentioned in the opening paragraph. However, it does paint a picture of a problem of the upper class not saving adequately for retirement.

Personally, I have mixed feelings about seeing this. On one hand, my wife and I are doing much better than the averages here and we are only 36. (I wonder if my generation saves more or if we are truly far ahead of the masses.) On the other hand, this paints a pretty bleak picture for dozens of millions of people in America in the coming years. When put that way, my feelings are no longer mixed, it’s just down. I don’t like to end things there, so here’s an unrelated inspirational video:

Editor’s Note: The link to the research comes courtesy of Jeremy from GenX Finance. I believe I saw it through a mention on his Twitter feed.