Have you been struggling with one of the biggest questions nearly every doctor asks themselves: What is my retirement number?
It’s a complex question, one that really takes some time and a well thought out plan to achieve.
So, today we are going to examine, in detail, an example of a physician who is trying to save for retirement but is unsure how much they should save. Here we go:
Step 1: Find Out How Much Income You Will Need Each Year In Retirement
A common rule of thumb in planning for retirement is that you need 70% of your current income to live the same or similar lifestyle during retirement. While this will not be the same across all professions, the good news for doctors is that the actual number is probably much less.
Why would the level of income needed be below the common rule? Well for many doctors, your tax burden is likely to be far lower in retirement. The reason is due to several large factors that are discussed below.
First, you won’t be paying Social Security or Medicare tax. Your income will be derived from your retirement accounts and will, for the most part, not be derived from “work” as you will now be retired. If you decided to move to a state without a state income tax, your tax burden could be lowered as much as 12.3% (12.3% in California; highest in the nation).
Federal income tax is likely to be lower as you will be earning income that is tax deferred or exempt and scales up as you withdraw more. Money withdrawn from your Roth IRA has already been taxed and is exempt from being taxed on withdraws. Withdraws from your 401k are taxed as ordinary income but is unique due to the fact that the tax rate scales higher as you increase your withdrawal amounts per year.
A more obvious detail that is often overlooked is that you don’t have to save for retirement when you are retired! If you have been saving 20% of your income, as recommended, that is 20% of your current income that you do not need to replace.
Another general assumption is that you have likely purchased a home during your career and that you have paid off your mortgage before retirement. Mortgages are usually 20% of your current income. Many retirees will not only have a home paid off but they will often sell their larger homes and downsize. Not only does this allow them to fund additional money into their nest egg, but will also decrease home maintenance and expenses. Most find that a large home is just too much home and unnecessary once the kids have left the house for good.
Many retirees will not only have a home paid off, but they will often sell their larger homes and downsize. Not only does this allow them to fund additional money into their nest egg, but it will also decrease home maintenance and expenses. Most find that a large home is just too much home and unnecessary once the kids have left the house for good.
Speaking of kids, do you have any? As much as we love them, kids are expensive. The good news is that most of the expenses relating to your children will be gone by the time you retire. You will have saved for college (or most of it) and wedding (if applicable) during your working career. Feeding, clothing etc. for your kid should be minimal by the time you hit retirement.
Another smaller point to consider is that there will also be a decrease in job-related expenses (mileage, work clothes, training etc.)
This all sounds great, except we all know that there will be increases in certain expenses at retirement. After all, you are retired and want to enjoy it right?! Traveling expenses are the most common expense increase, as well as medical costs.
While everyone’s situations are different, let’s give a quick example to illustrate the points illustrated in this post. Please keep in mind this does not take into consideration your spouse’s income, only yours. The example starts with the current salary and either reduces or increases expenses in order to determine how much income you will need yearly (in retirement) to live a similar lifestyle in retirement.
Current Salary: $200,000
Reduction: Elimination of taxes (State, Social Security, Medicare) – 15% – ($30,000)
Reduction: Retirement savings eliminated – 20% – ($40,000)
Reduction: Mortgage paid off – 20% – ($40,000)
Reduction: Home Maintenance and Expenses – 5% – ($10,000)
Reduction: Job Related Expenses – 2% -($4,000)
Reduction: Kids – 5% -($10,000)
Current Salary needed after all reductions: $66,000
Addition: Increase in Travel and Medical – 20% – $40,000
Current Salary after all changes* – $104,000 (52%)
Prior estimated income needed at retirement: $140,000 (70% of current income)
*Note – I have intentionally left out any Social Security benefit for the above example as it is unlikely that anyone under 40 today will see any funds from SS in its current form. If you want to factor in the potential benefit you could receive or if you are above 40, you should reduce your “current salary after all changes” by roughly $35,000. This would change this number down to $69,000 or 39.5% of your current salary.
After reviewing the above example, our doctor friend will only need $104,000 to live a very similar life during retirement as they enjoyed pre-retirement. This resulted in only needing to plan for 52% of their current income, not the general assumption of 70%.
Step 2: Figure Out How Much You Need To Save Prior To Retirement To Maintain The Same Lifestyle
Now we know that we should be planning to live off roughly 52% of our current income a year during retirement, but how much does one need to save in order to get there?
Great question. Let’s dive a little bit deeper.
First, we need to know how much can our doctor friend take out every year. There is a well-known rule in the financial community known as the 4 percent rule. This rule states that retirees who withdrew 4 percent of their initial retirement portfolio balance and then adjusted that dollar amount for inflation each year thereafter, would be able to create a “paycheck” that would last for 30 years under average market conditions.
If we need to generate $104,000 a year, in today’s dollars, and following the 4% rule, a nest egg of roughly 2.6 million is needed. With the assumption that you are starting right now with 0 in savings, it will take you roughly 24 years until you can retire. If we factor in Social Security, it would allow you to retire in roughly 20 years.
There are two more ideas I want to mention before we finish:
- If you were to wait just one more year until you started saving for retirement, it would add almost two years to your overall plan. The power of compounding interest is mind-boggling when allowed to run its course of 25 or more years. The more you delay, the longer you will have to work or the larger the percentage you will need to save of your current salary to “catch up”. Remember, always pay yourself first, save for retirement, and then spend money on other items.
- Secondly, think about your savings rate. If you were to save 30% of your salary as opposed to 20%, you would be able to retire in roughly 19 years. That is half a decade earlier than if you only saved 20%! Boost up that savings rate and enjoy “the golden years” way earlier than your peers.
If you have any questions about the example above or about your own retirement savings plan, feel free to give me a call. Initial consultations are free, and I’m always happy to chat!