How Much Money You REALLY Need to Retire | Financial Independence Is More Affordable That You Think

saving up for a goal as big as financial independence and or retirement can seem pretty daunting it just seems to require such an insane amount of capital that it can seem nearly impossible to accomplish for anyone who's not either getting started with their investing early on in life earning a ton of money at work or being fortunate enough to come into a large sum of money through some big investment or other means and don't get me wrong it is a big goal and it definitely is easier to achieve by a long shot if you're starting earlier in life or if you have a lot of money coming in that you can invest but that doesn't necessarily mean it's an insurmountable goal if you don't have those advantages and it might not actually be quite as large as you might think at first because if the numerous surveys and studies done on the topic are to be believed you probably don't actually need as much money as you think to achieve financial independence let's discuss why that is but before we get going be sure to like this video if you haven't already as it really does help out the channel a lot and subscribe with notifications on for more money related videos like this one every single week and if you want to further support this channel you can check out some of the links i've left in the description below which includes a 30-day free trial of audible and two free audiobooks of your choice as well as a list of some books on money i'd recommend checking out with your free trial most people that are just getting started on the process of planning for financial independence and retirement assume that they will need to be able to generate at least as much income as they did during their working years in order to live comfortably and on the surface that's a completely logical assumption i mean after all it would be a pretty poor reward to work our tails off for our entire working careers only to live on beans and rice and rice and beans during what's supposed to be our golden years however thankfully in most cases the same level of income isn't actually required in order to maintain the same lifestyle that you were living during your working career there's a phenomenon that's been observed in countless retirement studies over the years that's become known as the retirement spending smile the retirement spending smile is named for the shape of the typical inflation-adjusted spending of retirees in the studies as you can see from the image on your screen spending starts off right about where we would expect when you retire but over the years it tends to trend downward usually until somewhere in your 80s where the growing costs of age-related expenses usually in the form of medical bills start to overcome the continuing decrease in discretionary and other expenses that we typically see as people retire and age now granted not everybody is going to experience this same phenomenon some people may lead highly active and travel filled lives well into their 70s and 80s and see their inflation-adjusted spending hold about steady or even increase when they initially retire others particularly those with a higher proportion of discretionary expenses in their budget than the average person may actually see a slightly larger drop in their inflation-adjusted retirement expenses as they age and begin to lead more relaxed lifestyles but the general trend shown by the retirement spending smile seems to be pretty typical and has been replicated in numerous studies over the years but why is this why would we actually not need to spend quite as much money to maintain our lifestyle in retirement as we did when we were working and why would our expenses in retirement not actually tend to increase as fast as the overall inflation rate i mean isn't that one of the most basic assumptions of the four percent rule and just about every other retirement planning rule of thumb out there well yeah in a lot of cases it is and as far as i can tell the reason that these things tend to be the case comes down to a couple of key factors that change how our budgets look when we transition into retirement taxes lifestyle and behavioral changes and personalized assumptions taxes are pretty simple to figure out first since your income is no longer coming from your wages you likely aren't paying payroll taxes anymore that's essentially an automatic savings of 7.65 percent of your expenses right then and there and actually it's over 15 percent if you're self-employed second depending on how you set things up in regards to your nest egg you may be paying lower income taxes than before as well if you're getting some of your income from roth accounts there is no income taxes to speak of since you've already paid those during your working career and if you're selling investments in a taxable account there will be taxes but at least based on current laws you'll likely be paying the long-term capital gains tax rates which are generally lower than the ordinary income tax rates lifestyle changes are a bit tougher to figure out but for most people there will be some reduction in the expenses related to transportation since you no longer have that daily commute to and from work and assuming you're a homeowner there may very well eventually be a reduction to housing costs once your mortgage is paid off assuming it wasn't already before you retired you also likely no longer need to be putting money away for your future which is often a fairly sizable chunk of people's budgets especially in their later working years in and of itself and we can't forget the differences in discretionary spending that comes from those who are living on a fixed income you really are forced to prioritize when you're no longer able to simply pick up some extra hours and splurge on things and that tends to lower impulse spending and other forms of financial waste at least to some degree now granted especially in the first several years of retirement often referred to as the go-go years in retirement planning circles these reductions may be largely offset by increases in spending in other areas such as travel however as we age those expenses tend to become less frequent but the areas where we were experiencing reduced spending remain reduced and since those areas tend to also be some of the biggest line items in most people's budgets that can make quite a difference for instance say john and jane are nearing retirement they earn a combined 100 000 a year and they assume that they'll want at least that much to live on once they retire according to the four percent rule which states that a well-diversified portfolio should allow you to withdraw at least four percent of your overall nest egg in the first year of retirement with subsequent adjustments for inflation every year thereafter this suggests that john and jane will need around two and a half million dollars in their nest egg to be considered financially independent however if the goal is to maintain their current lifestyle in retirement they may not actually need quite that much this is going to be a bit of an oversimplification but just to put some numbers to it on a 100 000 a year income john and jane would be paying roughly 7 650 a year in payroll taxes but of course after they retire that expense will no longer be part of the budget if we were to say that they are saving roughly 25 percent of their income toward retirement as they're trying to make up for some lost time as many of us do as we're getting into those later years that's another 25 000 a year that will no longer be on the budget once retirement actually begins if we also say that they have a mortgage payment totaling say twelve hundred and fifty dollars a month on their three hundred thousand dollar home they'll eventually see even more savings once that homes paid off it'll cut their annual expenses by another fifteen thousand dollars a year transportation is admittedly a tough one to estimate but between fuel regular oil changes and maintenance the occasional large repair bill and depreciation let's say that jon and jane each spend roughly 50 cents a mile driven on their cars the federal government gives people a deduction of about 56 cents a mile for cars used for business purposes so this estimate is probably within the realm of possibility at least assuming they each commute to work five days a week and their commutes are 30 miles round trip that's a total of 60 miles driven for work per day between the two of them or about thirty dollars per day when all is said and done at thirty dollars per day five days a week for fifty working weeks a year that's about seventy five hundred dollars in transportation savings simply because they no longer have to go to work put that all together and that's over 55 000 a year that john and jane will no longer need to spend once retired which brings their actual required retirement income down from their initial expectation of a hundred thousand dollars a year to around forty five thousand dollars a year this drops their required nest egg down to around one point one two five million dollars from the initial two and a half million and that's before we've considered any reduction in discretionary expenses as time goes along or the impacts that the income requirements would have on the rest of the income tax picture after all you pay a heck of a lot more income taxes on 75 or 100 000 a year than you do on 45 000 a year now yes we would still need to add in additional expenses that they may want to have in retirement such as those additional travel expenses which would raise the size of that required nest egg somewhat so the forty five thousand dollars is lowballing it and yes medical expenses will almost certainly rise for them as time goes along as well but even with that you can see how a hundred thousand dollars a year may not be needed initially especially since those areas where they were saving on costs stay with them throughout retirement and barring some really bad luck it'll take quite a while for john and jane to reach an inflation-adjusted 100 000 a year in expenses again and during the time when their expenses are lower than that initial estimate their nest egg will be able to continue to grow john and jane could actually further secure their financial position by protecting themselves against some major foreseeable expenses by taking care of them before they leave their jobs some examples of these expenses would be buying a new car to replace their old one or repairing something on the home that they know is going to come up within the next few years the same could be said about finding passive ways to reduce their costs for instance some people have installed solar panels on their home not just because they're more green although that is certainly a consideration but also because they help to save money on utilities sure it may not make quite as big of a difference as some of the things we just went over but still when you need to have about a hundred dollars put away for every four dollars that you want to spend which is essentially what the four percent rule assumes based on the historical investment data we have then even something as small as forty or fifty dollars a month in electricity savings does add up after all fifty dollars a month is six hundred dollars a year which according to the four percent rule translates to a reduction of fifteen thousand dollars in the size of nest egg you're required to have to be considered financially independent so this kind of planning can make a difference as well and it helps to explain why we may not actually need quite as much money as we'd initially think once we reach retirement there's also another wrinkle to this whole thing minimum safe withdrawal rates are pretty conservative i mean by definition they are the withdrawal rate that would have allowed you to go through the entire retirement period which in most studies is assumed to be 30 years though some models use different lengths without outliving your savings in the worst circumstances we've seen in recorded financial history but most retirements will not begin right before a deep and prolonged crash like the great depression most retirements will not begin shortly before a decade filled with multiple crashes and sustained levels of high inflation like we experienced in the 1970s and early 1980s most retirements are going to be able to sustain much higher safe withdrawal rates than the minimum for instance based on the yearly data set that i have an all s p 500 portfolio would have maintained a minimum 30 30-year safe withdrawal rate of roughly 3.68 in any given starting year since 1927 at least before things like taxes and expenses were taken into account but the median or middle of the road withdrawal rate that it would have sustained was 7.36 basically doubling the minimum rate the maximum rate was a whopping 12.54 so you can see what i mean there's quite a wide range now that doesn't mean that we should just do away with the considerations given for the minimum safe withdrawal rates i mean they exist for a very good reason to give us an idea of the worst case scenario based on historical information we have and the assumptions we make but it does mean that in most cases in reality we'll see our nest egg actually grow larger as the years go by in spite of the fact that we're regularly taking money out of them to live on beyond that they're also highly dependent on the underlying assumptions made in the model for instance the 4 rule assumes a balanced portfolio of stocks and bonds with annual adjustments to withdrawals to account for inflation as measured by the cpi but not every person is going to employ that strategy as we've covered previously on this channel there are things you can do to further improve your chances of making it through retirement with money to spare and or increase the income you can generate off of your nest deck and as we've been discussing today most retirees don't actually see their expenses in greece in line with inflation as measured by the cpi in fact for the vast majority of those in their golden years it seems as if their expenses rise at a slightly slower rate than the cpi would suggest at least for the first several years and this makes sense as there are some expenses that the cpi covers that many retirees just aren't as affected by as others such as the fluctuations in fuel prices and of course there are some expenses that many just no longer have anymore such as a mortgage or rent payments so those fluctuations don't really affect the retirees budgets as much as most people if they affect them at all the exact amount that the typical retirees increasing expenses trail inflation by each year vary from study to study but the majority of them that i've seen tend to fall somewhere between an increase in expenses that's about one to two percent per year below the rate of inflation depending on factors like the proportion of their budgets that are dedicated to discretionary expenses and whether or not the retiree is recently retired has been retired for several years already or is entering the late stage of their retirement when medical bills and other costs are starting to outpace their savings in other areas and if we were to factor this into our safe withdrawal rate simulations it would make a noticeable difference for instance if we assumed that john and jane's expenses in retirement would grow at a rate that's one percent below whatever the overall inflation rate as measured by the cpi was for the year so in other words if inflation as measured by the cpi was three percent one year john and jane's expenses would rise by two percent then the minimum safe withdrawal rate for their all s p 500 portfolio would jump from 3.68 to 4.06 percent if their expenses grew at a rate that's two percent below the inflation rate then their minimum safe withdrawal rate would jump all the way up to 4.48 percent and if john and jane also used things like cash buffers flexible spending budgets and financial guard rails as we've discussed in other videos using the assumptions that you see on your screen now while seeing their expenses grow at a rate that's two percent below inflation the minimum safe withdrawal rate would jump to a whopping 10.66 percent all of a sudden john and jane's 100 000 a year retirement budget is able to be supported on about 938 000 maybe even less depending on what their actual retirement spending budget ended up being once all the adjustments we've discussed were taken into account so that's why you probably don't need quite as much money as you'd initially think to reach financial independence and if you so wish to retire the initial estimate of how much money we'll actually need to maintain our lifestyles after making the transition are often more than we'd actually need in reality due to changes in our lifestyles our behaviors and income sources and for some the safe withdrawal rates we usually discuss in the financial independence community may actually be more conservative than they ultimately end up needing depending on their own personal financial situation and what happens after they retire so i know that saving for financial independence can seem like a daunting task especially when you're just starting out and like i said at the top of this video it is it's a big challenge but if you take anything away from this video let it be this daunting does not have to mean insurmountable because there are tons of things that we can do to better set ourselves up for financial success but that'll do it for me today once again if you enjoyed this video be sure to smash that like button if you haven't already subscribe and hit that bell next to my name so you'll be notified of all my future uploads i generally upload every single monday and if you have a friend that would be interested in this kind of content be sure to share it with them let's really get this information out there and start our own financial revolution

Channel: Next Level Life

Views: 119,791

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Id: 73UNbcKsyOA

Length: 15min 27sec (927 seconds)

Published: Mon Sep 20 2021