I saw a chart recently in J.P. Morgan’s Guide to Retirement (slide 10 specifically) – that I also made a social media post on. Thinking about it more, I figured it would be a great topic to write on. It’s just such a common fallacy and huge worry for those who are nearing retirement. Having enough in today’s America is a rare figure to find. But having enough to functionally retire, or at least replace in your employment income is something I find many people work way past or have the number totally wrong.
Key takeaways:
- Replacing your employment income probably requires less than you think
- Taxes & savings will eat 25-35% of your employment income
- We see many people working longer due to a misunderstanding of what they really need to retire
What is “enough”?
Defining “enough” is one of the toughest concepts in all of finance. Does anyone feel like they have enough? I think Billionaires would tell you there’s always something else. Anyways, for the purposes of this blog we’ll be talking about maintaining a quality of life from a spending standpoint.
Let’s say as an example the last few years of work, you’ve been mostly working remotely at your home in Lewes, Delaware. That affords more time at the beach, biking, and really ebbing into retirement – the kind of pre-retirement lifestyle that’s become increasingly common along the Delaware beaches from Rehoboth to Bethany Beach. You’ve done some budgeting as you begin to think about what transitioning into retirement might look like.
$120,000. That includes your mortgage, car payment, going out, some gifting to help out your kids, and really enjoying your time at the beach.
That’s step number one. Could you spend more? Who couldn’t? But there has to be an acknowledgement of the quality of life we’d like to maintain. A step further would be breaking that number into variable and fixed expenses.
The more granular you can get with the number, the better the withdrawal strategy, planning, investments, and the list goes on. But that isn’t the purpose of this blog!
Where does your paycheck go?
Once the spending is tabulated – you turn to your income. This year, between spouses you figure you’ll be bringing in about $250,000. That feels great compared to the budget number you just put together. So much room in between those numbers you could build a Walmart.
But why then does it feel like you’re only saving a few hundred dollars and maybe up to a thousand a month on top of your retirement savings?
When your working, your saving and paying FICA (payroll) taxes. Your earnings need to be considerably higher to not only accumulate but maintain the same quality of life compared to when you retire.
For our $250,000 couple who are married filing jointly, let’s assume both are over age 60 and max-out their employer sponsored retirement plans. All wages are W-2, and since you’ve been spending so much time at your beach home in Lewes, Delaware, you’re a Delaware resident – which matters quite a bit come tax time, as we’ll show.
| Gross W-2 wages | $250,000 |
| 401(k) contributions (2 × $31,000) | ($62,000) |
| FICA taxes | ($19,125) |
| Federal income tax | ($24,588) |
| Delaware income tax | ($10,743) |
| Annual take-home | $133,544 |
That’s a good bit going to tax! And savings! For this family the marginal rate is 22% (22% federal income tax on the next dollar earned) and a 21.78% effective tax bill when factoring in FICA, Federal, and state income taxes. The savings rate is 24.8%.
How far does your retirement income go?
Let’s say this married couple are both retiring at age 67, their full retirement age for Social Security purposes. They each have an annual benefit of $30,000, or $60,000 total.
They have also saved a considerable portfolio of $3,000,000. $2,000,000 in pre-tax 401(k)s and $1,000,000 in after-tax assets in a joint brokerage account.
Since they have worked with a savvy financial advisor (wink) – they’ve determined they plan to withdraw from their after-tax joint account first. This allows them to minimize their tax liability on generating the necessary income to meet expenses and purpose other tax planning opportunities.
So their income looks like this:
| Social Security income | $60,000 |
| Brokerage withdrawal | $70,000 |
| Federal income tax | $0 |
| Delaware income tax | $0 |
| Annual take-home | $130,000 |
The tax owed on Social security in this scenario is completely wiped out by the significant standard deduction and the new enhanced senior deduction provided from the One Big Beautiful Bill Act.
Capital gains are taxed at 0% when taxable income is under $96,700, and in this example we’re assuming 80% is a return of basis instead of an entire capital gain from proper portfolio management. Another tool a savvy advisor should be paying attention to (wink).
The biggest surprise for most people is that $130,000 of income will mean $0 in income tax. This is a great example of good income planning.
As a withdrawal rate, this couple would only be withdrawing 2.3% of their portfolio annually. Historically, a 4% withdrawal rate is considered “safe” – being low enough to endure even the worst of historical market scenarios. If our hypothetical couple’s spending didn’t change too much over time, they’d likely end up leaving multiples of their original $3,000,000 to their heirs.
In year one of retirement, this couple is successfully meeting their spending with a 52% replacement ratio, the dollars going much further than their paychecks.
What people get wrong asking the “do I have enough?” question.
For a high income couple earning $250,000 a year, it isn’t unreasonable to ask yourself if having $3,000,000 saved is enough . After-all, a quick google search indicates most common rules refer to the fact that you should have 10-12 times your annual income in order to retire. That would put this couple right in the strike-zone, but most people might view that as “average”. I’ve seen people look at that number and think they may need to work even longer!
The reality is based on this couple’s spending requirements, retirement probably could have come a few years earlier if they desired.
This isn’t to say I’m telling everyone that you need far less than what you expect in retirement, but the math would tell you for most people that is indeed true. Interestingly enough, the lower the income, the less this is true.
As an example, for someone with a $50,000 income they will likely need to replace virtually all of that from their resources. The reason being that FICA taxes, savings, and overall tax liability are considerably lower. So, the “gap” that exists due to taxes and savings isn’t going to be as big.
The opportunity as you near retirement
For those who are reading this from their beach house in Lewes, Rehoboth Beach, Bethany Beach, or anywhere along the Delaware or Maryland shore wondering if they can retire, I’d proffer you may be in better shape than you think.
I don’t often see too many individuals going through these calculations in determining their retirement readiness.
While it may make sense to continue to defer taxes in the latter years of your working career through 401(k) withdrawals, there could be other opportunities to spend, pay-down debt, work-part time, or re-allocate things instead of continuing to beat the same horse you’ve ridden for 30 years.
We’ve written elsewhere about the significant tax planning opportunities this gap creates. In our example above this would be a prime example to consider partial Roth IRA conversions, tax gain harvesting, managing IRMAA penalties, gifting, and a plethora of things that can maximize your dollars and further increase your probabilities of success.
In summary
There are many topics in financial planning that I often see misconstrued or taken to a level that make them impractical. One of those is that writ large as a country we are so far behind in retirement savings. While we can do better and help more in this country build retirement wealth, the reality is most retirees are probably in better shape than we think.
It’s worth understanding how the change in retirement income will affect each individual to maximize their plan and optimize their life so they can minimize regret and maximize their lives. That is the whole point.
Ready to run your own numbers?
The math in this post is real, but every situation is different. Your Social Security benefit, the composition of your portfolio, your Delaware county of residence, Medicare premiums, and your specific spending number all change the outcome meaningfully. If you’re within five years of retirement and haven’t stress-tested your number with someone who actually runs these calculations – not just a retirement calculator on a brokerage website – that’s exactly the conversation we have with clients at Back Bay Financial Planning & Investments. We work exclusively with retirees and near-retirees in the Delaware and Maryland beach communities, on a fee-only, fiduciary basis. No products, no commissions, just a plan.
Reach out to schedule a complimentary introductory call and let’s find out if you have more than you think.
