Will You be Able to Retire?

Roughly 10,000 Americans will retire each day for the next nineteen years. Many millions of these retirees will have financial profiles that are considered statistically average.

What, exactly, does it mean to be financially average, and what might retirement look like for the average person or household? How might the financial aspects of retirement play-out for you, your parents, or your family and friends?

Let’s take a look at some data sources to consider the average profile and how it may apply to your situation. For simplicity, I’ll give the average American retiree a name – I’ll call him William.

Who is William?

Let’s lend some definition to William by building a financial profile:

First, it might make sense to refer to William as median rather than average since we will use median statistics that are not skewed by wealth concentrations.
I’ll assume that William falls in the 55 – 64 age range and is presumably near or at retirement age.
In 2009, the median household income for the 55 – 64 age range was $56,973.
Median net worth statistics come from a recent Federal Reserve report titled “Surveying the Aftermath of the Storm: Changes in Family Finances from 2007 – 2009." This report noted that in 2009 the median net worth (including the value of a primary residence) for households in the 55 – 64 age range was $244,000.
The average Social Security benefit for a retired couple in 2011 is $22,884.
Let’s assume that there is no pension income from an employer-sponsored defined benefit pension plan (defined benefit pensions are different from 401k plans) since these types of plans have become all but extinct in the private sector over the past thirty years.
The expected present value of lifetime uninsured healthcare costs (including insurance premiums, out of pocket costs, and home health costs) for a typical couple age 65 is $197,000.
Include the cost of nursing home care to the figure above and the expected value of lifetime uninsured health costs is $260,000 (with a five percent chance of exceeding $570,000…).
Let’s assume that William is 60 years old and in good health. William’s life expectancy at this point is 17.9 years.
Let’s further assume that William is married, and that his spouse is also age 60 and in good health. The probability that William lives to age 90 is 9.2 percent, while the probability that his wife lives to age 90 is 20.1 percent. The probability that at least one person in the couple lives to age 90 is 27.5 percent.
Last, let’s assume that William and his wife plan to retire at age 65.

What are William’s Retirement Income Needs?

So, William needs to think about financing some portion of his pre-retirement income ($56,973) and future health spending over a very long time horizon – at least 20 years. At a minimum, William should think about a 17.9 year planning horizon, which leaves roughly 13 retirement years if he retires at 65. A more prudent planning horizon would be 20 - 25 years since there is almost a 1 in 3 chance that either he or his wife will survive to age 90.

The resources available for this long-term financing of William’s retirement include $244,000 in private wealth (a good portion of which is in the form of relatively illiquid home equity) and $22,884 in inflation-adjusted regular payments from Social Security.

The following is an approximate assessment of William’s retirement income needs:

Let’s go with the conventional assumption that retirement spending should be based on 85 percent of pre-retirement income. Based on this assumption, William needs to generate $48,427 per year in after tax income. Let’s not forget that this $48,427 will need to increase each year to keep pace with inflation.
William receives $22,884 per year in inflation-adjusted income from Social Security. This leaves a net after tax income requirement of $25,543.
For the purpose of simplicity, we will leave-out any consideration of taxes on William’s Social Security payments. However, William may have to pay some taxes on his Social Security income.
Determining the impact of health costs on retirement spending is a bit tricky since there are a number of ways to finance healthcare expenses. For the purpose of determining the impact on annual retirement spending, let’s use the annual payment that is required to finance the expected present value of $197,000. Using this approach, the expected out-of-pocket health care expense assuming no nursing home costs over a 20 year time horizon is $14,495 per year.
Adding the above health expense to our previous net after tax income requirement (that was net of Social Security payments) leaves William with a total after tax retirement income need of $40,038 per year.

Can William Make it?

The bottom-line is that William needs to figure-out how his $244,000 nest egg can finance $40,038 per year for 20 years.

Before discussing how this might occur, however, let’s first take a look at whether it is at all likely that William can retire based on his current needs and resources.

Stay tuned—the next article in this series will explore this issue in detail.

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