What is your retirement number?

What is your retirement number? kcchongnz

Benjamin Franklin — 'If you fail to plan, you are planning to fail!'

Generally people understand the “Retirement number” as the amount of money we will need to have socked away in order to be confident that our post retirement income and retirement life will meet our expectations. Except for the fortunate few who don't have to worry about money, the “Number” has become the holy grail in retirement planning. So what is your number?

Someone told me if one has one million ringgit cash now, he can then retire, assuming that he is debt free, already owned a house, and his children are all financially independent. Do you agree? For me, it is yes and no. This is because everyone's retirement number is different, so stay away from others. This number depends on a number of factors for each individual, among them:

1. How large is your required pay check?
2. What other source of retirement income that you have?
3. How do you generate your retirement pay check?

Retirement Planning: A Simple Approach

Table 1 below shows how much one can withdraw at the beginning of each year with one million ringgit now for different rate of return and number of years of withdrawal.

Table 1: Annual withdrawal for 1 million ringgit principal for various years of retirement and return

Return/ Years in retirement	10	15	20	25	30	35	40
2%	91490	57989	41318	31377	24802	20149	16697
4%	100000	66667	50000	40000	33333	28571	25000
6%	108787	75918	60000	49801	43345	38776	35384
8%	117817	85681	69895	60643	54653	50521	47544
10%	127056	95884	80892	72346	66999	63456	61018

Note: All in today’s ringgit

The amount of annual withdrawal is computed based on the assumptions of a portfolio of cash and equity in various proportions, with the long-term return of cash and equity of 4% and 10% respectively, and an inflation rate of 4%. For example, if you are 55 now and assume that you are going to live up to the age of 75, and the weighted average return of your portfolio at 6%, you are able to withdraw a real amount of RM60,000 a year for the next 20 years. You can withdraw a nominal amount of RM60,000 for at the beginning of next year, RM62400 one year later, RM64900 the following year and so on, until all the money is all used up 20 years later. The amount increases each year by the rate of inflation, but they all have the same purchasing power, i.e. the present value of RM60000. Of course for those who needs a real amount of RM120,000 a year pay check, he need to have double the amount of liquid assets he has now.

RM60,000 withdrawal in today’s ringgit may be enough, or even abundant for many people who are completely debt free and with no other heavy obligations like children’s education, home mortgages etc. One may say that if it is not enough, he can increase his rate of portfolio return to 10% by putting all his assets in equity! How easy? I can see this will open to fierce argument regarding risks and the equity market which we better leave it to another chapter. For others who would prefer to enjoy their fruits of labour to lead a more luxurious life, such as having a bigger house, a better car, or to travel to Europe, US, South American etc, RM60,000 a year is definitely not enough.

Hey, have we consider if the actual return is not as expected? What if the portfolio only return 2%? You can only withdraw RM41300 a year without running out of money in 20 years time as shown in Table 1, or about 30% less! What if you are so durable and only expire in 30 years time? What if the inflation rate jumps to 8%? Are all these possible?

Retirement planning is fraught with important assumptions about many significant, unpredictable events, which can substantially impact cash flow calculations and results. There are simply too many scenarios and variables, both internal such as lifestyle choices, risk appetite and changes when get older; as well as external factors such as inflation, health care costs, variation of interest rate and market return, longevity, unexpected life events etc. That is why I like to do the retirement  planning in an annual cash flows basis such that these variables can be adjusted easily at different stages.

Retirement Annual Cash Flows

This annual cash flow analysis can help you determine whether you will outlive your assets. The expenses can be broken down into different categories, discretionary or non-discretionary, fixed, temporary, or changes along the retirement life span.  The return will change as for example, one may find his net worth reduced drastically after another financial crisis. In the later part of life, a retiree may have to allocate more if not all his assets into lower risks investment and hence a lower expected return. Many of us may still have one or two children who are depending on us, and the cost of education, which though is for another few more years, can be very high. Some people may still have a housing mortgage to pay for another few more years. With all these incomes and expenses put into a spreadsheet, an annual cash flows projections can be seen clearly. However, bear in mind that this plan is just an "initial" plan, not a real life.

Retirement annual cash flows, a case study

Ah Meng is 55 years old now and his wife is two years younger. They have worked hard for the last 32 years and accumulated some assets, a house worth a million ringgit which still have 10 more years to pay off at RM2500 per month. They have RM200,000 in bank cash and fixed deposit, RM300,000 invested long–term in shares and unit trusts, and a total of RM1,000,000 in EPF. Ah Meng is working as a senior engineer in a public listed company with a total net income of RM150,000 a year (EPF included). As they have 2 more dependent children, one with 3 and the other with 6 more years of study to graduate, he thinks that it is better for him to work another 6 years before retiring at 61. Ah Meng intends to let their children study in Taylors college and then send them to Australia in the final year to complete their course. As Ah Meng is a super risk taker, he intends to withdraw all their EPF money and use them to invest in the equity market to earn a higher expected return, after all, he still has a steady income. He has a life and TPD insurance covering RM500,000 until age 61 and he is paying RM24000 premium for it now. Their household expenses is RM72,000 now and after retirement, he figures that this non-discretional expenses will reduced by 25%. He recognise the high cost of medical care when he retires and he decided to set aside RM100,000 for this purpose. Ah Meng’s wife like to travel and they intend to carry on spending about RM5000 a year for this purpose until they retire. After Ah Meng retires, they will have more time together and intend to travel more overseas and budgeted RM10,000 a year for this purpose. They realize that when they get older, say at 74, they may not be able to travel that often. However they know that their health care will also increase then. Ah Meng did not forget that he has to have money available, say RM80,000  to change to a new car every 10 years. A Honda Civic may be good enough then. The following are some data and assumptions:

Table 2: Data and Assumptions

Cash in banks:                         100,000           after setting aside for medical of 100,000

Equity:                                     300,000           in Malaysian shares and unit trusts

EPF:                                         1,000,000        To withdraw and invest in equity

Value of house and cars         1,000,000        Not included as liquid assets

Present income                       150000/year   Wife works as home Finance Minister

Life/TPD insurance                 RM500,000     Premium RM24,000 per year

Long-term inflation rate:        4%                   Average rate

Return on Equity:                    10%                 hence real return R=(10%-4%)/(1+4%)

Saving interest rate                5%                   Real return 1%

Portfolio mix: Equity : cash     93% : 7%          before retirement.     

50% : 50%        after retirement.       

All cash            after age 85

Annual Cash Flows: The Base scenario

With the above data, Ah Meng’s goals and objectives and the assumptions used, his annual cash flows will look like the following Figure 1. The figure shows that Ah Meng and his wife has no problem living up to 90 years old with the standard of living expected without running out of cash before that. In fact they are likely to be able to leave a legacy of RM200,000 in today’s ringgit to their children, plus the house they have which would have worth a lot of money.

Figure 1: Annual cash flows: Base scenario

^{Note: In today’s ringgit}

Even with reasonable assumptions about investment returns, inflation, and retirement living costs, it's likely Ah Meng will encounter numerous changes to his cash flow over time. What if say the return from equity is 2% less than expected at 8% CAGR?

Reduced return scenario

Figure 2 below depicts a scenario where the long-term return from the equity investment is reduced by 2% from 10% to 8%. This is assuming that the return of equity is not as good as historical because of some of the problems in the world now, such as the enormous trade deficit of the US and the Euro sovereign debt crisis. Moreover, the corruption problems of politicians at home and the indiscrete manner the government is spending the money are also extremely worrisome.

Figure 2: Reduced return from equity by 2%

In the above scenario, with the same income and expenditure but at a reduced return, their money will be finished by the time they reach the age of 77 as shown. Incidentally, that is the approximate mortality age of a Malaysian Chinese female. However, Ah Meng may not be too comfortable with that as according to statistics, at least one of the spouses has a high probability that he or she will live much longer than that. Ah Meng can then adjust his plan; maybe work another 3 years longer, go less for expensive overseas holidays, maybe visit more of China (instead of Europe and other Western countries) as there are heaps of places and interesting things to see and do there too; buy a smaller car etc. They are aware that in the worst case scenario, they still have a house to fall back.

                                                                                                                               

Conclusions

Everyone has his own retirement number according to individual needs and wants, which often varies at a wide range. One must pay attention to external factors such as inflation, volatility of returns, unexpected medical cost and his own longevity which can significantly impact on his “number”. With a retirement annual cash flows projection, one can simulate various scenarios and see where he is at different stages of life. Frequent monitoring of his income and expenses will detect changes that he can take appropriate actions to ensure that the money he has can last for a satisfying retirement before his own expiry.

KC Chong (CFP)

01/04/2014