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Do You Really Need Ten Times Your Income To Retire?

Hedgematic Says “Not Likely”

Background

Two recent stories in the Wall Street Journal:

  • In The New Magic Number for Retirement Is $1.46 Million. Here’s What It Tells Us. Anne Tergesen reports on a newly released survey where respondents declared they needed $1.45 million in order to “retire comfortably.” Cited authorites differ on whether this is true, but none are able to provide a confident answer without falling back on crusty “rules of thumb” (Fidelity suggests ten times your income) or disclaimers that “everybody’s situation is unique.”
  • In You Don’t Need to Be a Millionaire to Retire Andrew Biggs takes a side. He notes that “the average U.S. adult has saved only $88,400 for retirement,” and points to another survey that found “Of the seniors with more than $10,000 in retirement savings, less than 1% said they were finding it hard to get by, while 93% reported they were doing OK or living comfortably.” He cites failure to account for Social Security’s surprisingly generous benefits, diminishing spending through retirement, and conventional financial planning recommendations as potential explanations for this discrepancy.

Getting a Better Picture of Your Unique Requirements

Hedgematic is an app that, based on your unique position, constructs a hedged after-tax income stream to cover your individually specified yearly needs for the duration of your retirement. Figures are expressed in today’s dollars and are tax-optimized. Allocations are made via a public algorithm, with sound economic support.

Putting Hedgematic to the Test: The Profile

Let’s see how it works for a household in the 80th percentile. You make $153K per year. Your spouse stayed home. Following Fidelity’s recommendation, you’ve accumulated $1.5 million in assets, a million in an IRA and 500k in a Roth. Your 153K income yields 124K after adjusting for taxes, social security and other deductions. You’ll wait two years to retire and then start drawing 124K. You opt to start Social Security at the default retirement age. Hedgematic computes death dates based on an entered lifespan percentile; in this case you’ve got 30 years. Here’s the profile:

Your profile summarizes the decisions recorded in the previous paragraph

Cut to the Chase

You made it! You leave (an estimated) $850K to your kids. Note that a steady increase was interrupted only by your (timely) death, and attendant cut in Social Security.

Your assets are shown in a 30 year bar graph. They start at 1.5mm and finish around 850K

Hedgematic split your assets between a ladder of TIPS inflation adjusted bonds (blue) and the S&P (red). When this profile was computed, Shiller’s CAPE was very high, dampening outlook for market gains, and TIPS yields were up. As a consequence, the portfolio starts out heavy in inflation protected cash.

Check Out the Draws

It took you 15 (relatively) risk-free years to start drawing down your S&P!

A bar chart showing yearly draws. the bars are all 124K tall, except for some bumps in the first few years.

Note also that some of the draws are larger than the others. Hedgematic provides after-tax income, so the draws include tax obligations.

More About Taxes

Here’s the tax returns for your retirement. The black line shows taxes. You pay very little tax.

A bar chart showing taxable income over the years. The amount of tax is shown by a black line that hugs the zero mark.

Note the flat spot in the middle. Every one of those bars hit the standard deduction exactly. Hedgematic seeks the lowest tax rate, then combines draws and rollovers to hit a yearly target.

Constructing the Portfolio

Hedgematic gives you year by year transactions for each of your accounts. Here is what you do with your IRA on day one.

A list of purchases for your IRA on the first day. It includes a S&P buy, and yearly TIPS bond purchase.

You start with a million. Roll 29K to your Roth. Buy 45.82 “S&Ps” at 5291 each for 242K. Spend the remainder on a TIPS bond for each immediately upcoming year. These redemptions, added to your 66K social security (including spousal) will support you well into your retirement while your Roth bubbles along.

Everything is held to maturity, including S&P. That S&P buy actually is the sum of multiple smaller tranches, each targetting a single year. When the year comes, you might be directed to “Sell 14 S&Ps”. You multiply 14 by the current average and sell that much. Your net paycheck is more often than not more than your 124K expectation, but might come in low too. But you never run out.

But Wait, There’s More.

That’s just one scenario. You can vary yearly spend, life expectancy, social security start date, or risk aversity, and recompute.

For example, in the above case, you replaced your after tax income. You think about it and realize you’re not going to be sending that 13K to your IRA every year. Make a new profile and run it.

Assets are shown for a new profile with 13K less spending each year. The final total is over 2 million dollars.

It turns out that final results are sensitive to starting conditions. Looks like little Jason and Jessica come into a million 2024 dollars each, and that’s before they sell the house. You look at that and think that maybe you could bump up your early retirement travel budget a bit . . .

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