It may seem obvious that the top 1 percent of earners can afford to retire. There are, however, distinct changes that must take place in order for these retirees to keep up the lifestyle they had during their working life.
“Most people, regardless of income, have a hard time maintaining their standard of living when they retire,” says Jim Budros, chairman and founder of Budros, Ruhlin & Roe, Inc.
Determining what it will take to replace that income is the toughest question to answer, especially if the answer is based on commonly held, but false, assumptions.
Smart Business spoke with Budros about retirement planning for high-income earners.
How much money does someone in the top 1 percent of earners need for retirement?
The simple answer is that a portfolio designed to not run out of money during one’s lifetime might require $8 million. To get to that number, a person must accumulate assets that represent that value during his or her productive life.
Some in this income range falsely assume that Social Security payments can help offset that income requirement. Social Security, however, has little value for those accustomed to high earnings. Where, then, does one get the rest of the $7.5 million that is still needed?
How does someone calculate retirement spending?
Some people think they can adjust their standard of living downward during retirement, or that their spending will be less as a matter of personal choice.
Let’s say a couple retires at 65. The likelihood is that only one of them makes it to age 95. Retirement may encompass the last one-third of the couple’s lifetime. The last 30 years might be divided into three periods.
The first 10 years is the most active, ‘bucket list’ period, and is carried out with the greatest expense. The second period is a transition where likely one spouse dies. The surviving spouse, then, doesn’t need as much money and begins to readjust his or her standard of living. Health care is likely to take over as the dominant expense, depending on the person’s insurance coverage. The last period is probably occupied by one spouse with low, extremely fixed expenses.
Attempting to calculate the cost of retirement highlights the complexity of what can be called ‘decumulation,’ which is spending without saving. That means one has to spend at a pace that doesn’t risk exhausting one’s available assets during one’s remaining lifetime.
That’s a difficult shift in thinking because during the working years, a person is one point on a cash flow pipeline. Income moves from the payer to that point person, then along to pay expenses and then the cycle begins again with the next pay period. In retirement, there’s no flow. There’s just a big bucket full of money in the form of a 401(k), IRA and personal investments. A person in retirement, then, shifts from a pipeline person to a bucket person. That is a tough transition partly because the assumptions are difficult to make — how much longer the person will live, for example.
Is it safe for the top 1 percent of earners to assume they will be in the same tax bracket when they retire?
The tax bracket won’t change much in retirement for most of the 1 percent. The largest source of their wealth is typically retirement plan accumulation, which is all pretax dollars. Every dollar that replaces one’s income from that source is taxable. If a portion of their portfolio isn’t in after-tax vehicles, when any money comes out it’s all taxable.
When should someone start thinking about retirement planning?
Thinking about financing retirement requires one to consider his or her goals, then accumulate the savings and investment returns to meet that expectation. If those goals aren’t established in one’s early 40s, chances are those goals will be missed by a mile.
Wealth management firms base much of their business on questions of sufficiency. The answers form the basis of the most fundamental retirement concern, which is how much does one need to retire and how does he or she get there.
Insights Wealth Management is brought to you by Budros, Ruhlin & Roe, Inc.