How To Calculate Your 'Number'

Summary

• Back in 2010, the ING financial services firm popularized "What's Your Number?" for retirement planning.
• That campaign, though popular, was criticized as an oversimplification.
• What is really involved in getting a meaningful "number?"

Back in 2010, the ING financial services firm ran a marketing campaign asking what is "Your Number?" The purpose was to encourage people to identify and calculate the total amount of money they need to have saved by the time they retire. This campaign, though memorable, was criticized roundly as being too trivial and naïve and it oversimplified retirement planning to be of any real use. But, was that too harsh a criticism? What can we learn from "your number"?

Today's investment modeling software has taken a good stab at answering this question. MoneyGuidePro, one of the leading "fintech" planning software, does a good job at statistically calculating the "probability of success" of a retirement plan when all the relevant factors such as projected income, expenses, and investment portfolio are modeled. Your "Number" is only part of the answer but an important part. Let's see how it works.

Assume that you are 66 years old and your wife is 62 and you want to retire today. Both you and your wife are eligible for social security at the maximum benefit at full retirement age and age 62 of $3,011 and $2,265 per month, respectively; $63,312 per year combined (pre-tax) with an annual inflation adjustment. Let's also assume that there is no pension, annuity, or another source of income. Based on actuarial models, assuming good health, we can plan out 33 years; age 92 for the husband and age 94 for the wife.

With the income side taken care of, what about expenses? Most people have a standard of living that they have become accustomed to and want to maintain it into retirement, including inflation. How much that costs are specific to each family, but we can take some short cuts to model it out. For example, for our sample family, let's assume that they spend a level of $6,000 per month (after-tax) to support their lifestyle (though we know spending is not "level") and it inflates by 2.25% per year.

Now, let's get to the investment portfolio; the part of the equation we are trying to solve for. Once all the factors are populated into the model, we can work backwards to determine statistically how large your investment portfolio should be to provide a safe "probability of success", i.e., the level where you have enough income and assets to cover your expense through the "end of plan". For this example, we will assume a 50% equity weighting with 70% of the investments in tax-deferred vehicles (IRAs, 401-ks, etc.) and 30% in taxable accounts.

So, run the model and the answer pops out: for this fictional family, their "number" is $490,000. This means that there is an 80% probability of success (see chart below) that this family's social security income of $63,312 per year (pre-tax), expenses of $72,000 per year (after-tax) and investment portfolio of $490,000 is enough to last the next 33 years without a deficit. Higher living expenses would require more investments and vice versa.

Sounds good, right? Wrong! There are many things that could go wrong. The list is quite long and includes things like higher inflation, medical expenses and unplanned expenses, long-term care costs, increased taxes, early or late death, value of a home, etc. Also, there are many things that can impact the investment portfolio and the ultimate probability of success including the underlying risk profile, volatility and sequence of returns, investment expenses, and the asset class allocations.

Calculation of "Your Number" makes the most sense when you are close to retirement and want some assurance that you have the financial wherewithal to proceed with a degree of success; especially since there are no "do-overs" in this league. Since the inputs into the model are likely to change over time, it is important to update the plan on a somewhat regular basis or when there is a material change in something. For more on this topic, check out my prior post on our blog, here: Do You Need a Retirement Plan? - Dattilio & Ash Capital Management, LLC.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Tony Ash]

Was pecking around and saw that this Seeking Alpha article from last year got about 3k hits; good for my number of "followers". If anyone wants an update with some specific considerations addressed, let me know and I will write one up.

[OverTheHill]

It would seem appropriate to consider a hi-lo range for each assumption: for income, expenses and inflation. While still assumptions, this approach would tend to bracket "the number" and improve the chances of getting a realistic answer. Updating the assumptions annually, would tend to show the hi and lo forecasts converging as a person approaches retirement.

[hawkeyec]

Remember, the SS check you mention is before deductions for Medicare premiums. For a couple that removes $2500 off the top. However, if additional investments from the "number" produce income that medicare cost can rise.

[Tony Ash]

Right, the model looks at gross income before tax and medicare deductions. Medicare is handled as an expense. In fact, it is so important it is not considered part of general expenses and is itemized separately with a higher inflation rate. For this base case, i included Medicare in general expenses.

[Tony Ash]

Everyone, thanks for reading! Yes, there are many ways to improve the "projected" outcome. But, it only becomes a statistically better outcome, not a sure thing. In fact, the main purpose of MoneyGuidePro is to take a base case and test out and "solve for" ways to improve the solution. Optimizing social security income is exactly one of those ways to improve the plan.

[bionic1]

Entering retirement with ZERO unnecessary recurring debt is the best way to start...NO mortgage,car payment ,& especially NO rolling credit card balances!!These are things you have control over & will make the theoretical credit side much easier to manage!!

[El Contador Inversor]

These discussions will continue to be endless in opinions and thoughts. The takeaway, in my opinion: there is no perfect solution. All we can do is plan thoroughly. Unless you have endless resources the plan and your lifestyle will need to be flexible. Current environment is allowing us to stress test the plan when it sort of hits the fan. Your income may be taking hits in today’s events. Otherwise it’s about early saving, planning, flexibility and diligence. All the best. Good luck.

[glinsight]

I agree with @bionic1 the spouse should wait to FRA to collect SS.

However this, and other comments, miss the point. There are way too many variables and unknowns to pick a number. The author mentioned some of them. Add where do they live (state/local taxes), willingness to change lifestyle if need be, many others.

Finally, since (in the words of the author) there are no do-overs, I for one would not want a plan with only an 80% chance of success.

[bionic1]

Amen on the variables & do-overs..What I find annoying is how all these type articles gloss over the "debt" side prior to retiring..But once debt is gone you can't make as much money from managing the income side

[Tony Ash]

I should have attributed the "do-over" comment to Madden football on super nintendo way back when that was popular!

[bfried1052]

IMHO how many people get the max out of SS. Typical payment for a retired couple is probably closer to 40K before taxes That would have been a better starting place then $63,000

[bionic1]

True,but it's the method not the numbers..Someone getting $40k has been living on less all along so would need less when retired(hopefully).

[LazyCPA]

@bfried1052 - My understanding is that the average monthly social security check (before the deduction of Medicare premiums) is about $1,500, so for an average couple, it is closer to $36K a year and it appears that the average monthly medicare premium is just under $300 for a typical couple. The math would appear to work out to an annual social security income of about $32,500

[Tony Ash]

Right, my assumption of maximum SSI does not reflect reality for many couples. Lower income makes the need for more investments more important; but, since there was lower income, it would have been harder to accumulate more assets. if they weren't at maximum SSI, then they probably have lower monthly expenses and lower assets. Modeling out that scenario of a couple at less than maximum SSI needs to hold together all the factors to be internally consistent.

[bionic1]

If wife waited till 66 fra her benefit would be $3235/month.She should claim 1/2 of his =$1506 or -$759 now but in 4 yrs would jump up $1730 month..The $36422 lost in those 4yrs would be made up in 21 months & would be gravy after that!! If you wait until you're ready to retire to do this it's probably to late & should have been done 10 years out & revisited at 5 years to see how the plan is working...Good starting point,ZERO debt & min. 3 years est. income!!

[bionic1]

Error..Used her fra@67 by mistake..Her fra # would be the same @ $3011 so $36422/$1506increase = 24.2 months to breakeven

[$tart]

For a couple needing 8,688 inflation adjusted income almost half a million seems more than adequate. Dividing the 490k by 33 years shows $14,848.48 non adjusted amount available. Invested in annuities would provide 30k/year the excess could be invested, or I bonds inflation adjusted are easy. This situation isn't much of a challenge.

[Tony Ash]

I didn't double-check your numbers, but i agree with your thought process. Because this base case solution had a large "safety margin". i.e., excess assets remaining at end of plan, of $181k, there are many ways to take some risk "off" and spend this safety margin on an annuity or less risky investment portfolio.