1. Retirement Income Need: How Much Is Enough? George K. Chamberlin, JD Vice President – Financial Strategies F I N A N C E W A R E ®

2. Retirement Income Need: How Much Is Enough? ® Building PAGE 2 Retirement Income Need What Is It? Why Is It Important? How do we determine a client’s retirement income need?

3. Retirement Income Need: How Much Is Enough? ® Building PAGE 3 The First Step Be Guided by the Client » What does the client define as the necessary amount? Why? » Examine income and expense data provided by the client Be Guided by Your Experience » What amount feels right – and what feels wrong? » Ranges you have used for clients with similar situations

4. Retirement Income Need: How Much Is Enough? ® Building PAGE 4 The Initial Analysis Under the facts as stated by the client, will the client succeed in achieving his or her goals at the proposed level of retirement income need? Is the proposed retirement income need realistic? » Given the investment portfolio value stated by the client? » Given the current income and spending levels for the client? » Given the anticipated retirement date and life expectancy for the client? If the retirement income need proposed by the client is NOT realistic, you must set expectations at a supportable level.

5. Retirement Income Need: How Much Is Enough? ® Building PAGE 5 Validation Under the facts as stated by the client, will the client succeed in achieving his or her goals at the proposed level of retirement income need? Plug in your standard methods of determining retirement income need to this client’s case… » Compare the relative levels of success using each method and amount » Verify that methods and amounts chosen coexist with the client’s stated priorities and goals » Make your recommendations…with confidence!

6. Retirement Income Need: How Much Is Enough? ® Building PAGE 6 Retirement Income Need Analysis in Action: A Case Study The Best Way to Examine Retirement Income Need Is through the Case Study Approach First, we’ll look at the case of a married couple retiring in 15 years: Combined Income: $180,000 Investment Portfolio: $500,000 Annual 401(k) Contributions: $20,000 We will use a variety of approaches to determining the appropriate retirement income need….

7. Retirement Income Need: How Much Is Enough? ® Building PAGE 7 Income Based Approaches Approach #1: Need = Current Net Income » Very easy to apply » May have little relevance to actual need or potential for success » Value in our case study - $120,000 Approach #2: Need = Current Net Income, minus Expenses that end with retirement, plus Expenses that begin with retirement » Somewhat more complex » Actual reduction may be uncertain and future expenses may be unknown » Value in our case study - $108,000 Approach #3 (Formula): Need = Percentage of Current Net Income » The formula is relatively easy to apply » Using a percentage provides a range that you may work with easily » Value in our case study - $84,000 (70%)

8. Retirement Income Need: How Much Is Enough? ® Building PAGE 8 Comparing results employing income-based approaches: We evaluated 1000 simulations generating random returns. #1 #2 #3

9. Retirement Income Need: How Much Is Enough? ® Building PAGE 9 What can we conclude from these results? First, the results are wide-ranging and do not provide comfort that the clients will attain their goals – in fact, 47% and 57% are discouraging Does this mean that the approaches are of no utility? Not at all! Under the facts and circumstances stated, the measures used will not support the desired level of comfort But, they point us in the right direction… Adjusting the conservative formula to 65% of current net income - $78,000 - will provide sufficient confidence that our client will attain the retirement and estate goal with comfort.

10. Retirement Income Need: How Much Is Enough? ® Building PAGE 10 What if we assume the client’s annual household income was 20% lower? We evaluated 1000 simulations generating random returns. Retirement Income Needs used were $97,920 (Net Income), $85,920 (Income +/- Expenses) and $68,544 (70% of Net Income). #3 #2 #1

11. Retirement Income Need: How Much Is Enough? ® Building PAGE 11 Evaluating the results with different income levels… We knew that our approaches were income based…the variation in results when we change the income component is what we would expect. » The larger the income, the larger the amount of need predicted » And the larger the amount of need, the greater the burden on the investment portfolio and retirement inflows » Which in turn reduces the chances of success Now, the question is “How does the retirement income need amount generated by any of these approaches square with what the client actually needs?” » We don’t know, for certain » The amount so determined follows from what our clients say they are earning and saving…they must be spending the rest! » And isn’t the lifetime spending habit a good gauge of future spending?

12. Retirement Income Need: How Much Is Enough? ® Building PAGE 12 Additional Approaches to Determining Retirement Income Need Thus far, the approaches we have employed were based on the client’s income Another method of analyzing retirement income need is to utilize a budget approach…thus considering actual spending, directly » This would require the gathering of a great deal of information » The client…and the advisor…may not relish the prospect of this detail work » The amount so determined may have no relation to actual need…remember that our client is many years from retiring and a budget will really be guesswork

13. Retirement Income Need: How Much Is Enough? ® Building PAGE 13 Additional Approaches to Determining Retirement Income Need Alternatively, we might try basing retirement income need on a percentage of the client’s investment portfolio… » This would be very simple to implement…once we knew the “correct” percentage » Taking a percentage means that the portfolio never runs out of money » But, the funds available would vary from year to year and so, too the payouts » And if the percentage were greater than the return on investment plus inflation, the investment portfolio would tend to decrease over time, thus causing the payments to decrease as well » The percentage amount does not take into consideration the amount or application of other sources of retirement income such as Social Security and pensions…amounts available to meet need in addition to the percentage withdrawal

14. Retirement Income Need: How Much Is Enough? ® Building PAGE 14 Evaluating Results Using Percentage Methods

15. Retirement Income Need: How Much Is Enough? ® Building PAGE 15 What Do the Percentage Methods Show Us? Both the 7% and 9% portfolio withdrawals never run out of money…but they may not provide enough income to support the client’s spending requirement. When we look at the summary of cash flows for the 9% portfolio withdrawal, we see how the withdrawals fluctuate and generally decrease over time. The scenario that combines a withdrawal of an amount equal to Social Security and a percentage of the investment portfolio may work for some clients. The variation in payments is less marked but the total withdrawals may not be sufficient.

16. Retirement Income Need: How Much Is Enough? ® Building PAGE 16 Retirement Income Need Analysis in Action: A Second Case Study Next, we’ll look at the case of a married couple retiring currently: Investment Portfolio: $1,500,000 Pre-Retirement Income: $180,000 Again, we will employ a variety of approaches to determining the appropriate retirement income need….

17. Retirement Income Need: How Much Is Enough? ® Building PAGE 17 Approaches to Determining Client Need once Retired… Efficient Portfolio “C” Efficient Portfolio “A” Efficient Portfolio “B” Need = Actual retirement income (Social Security, Pension, etc.) » This method would not take advantage of the client’s investment portfolio as a means of funding retirement » This method may cause undue sacrifice on the part of the client Need = Net income in pre-retirement (A) » This dollar figure reflects the client’s actual pre-retirement lifestyle » However it does not take into account changes attributable to retirement Need = Pre-retirement net income adjusted for changes due to retirement (B) Need = Formula percentage of pre-retirement net income (C) » Variations of these methods were used in the first case study » We’ll use the same dollar amounts as in the first case study

18. Retirement Income Need: How Much Is Enough? ® Building PAGE 18 The Results Employing Variations on Pre-Retirement Net Income Efficient Portfolio “C” Efficient Portfolio “B” C B A

19. Retirement Income Need: How Much Is Enough? ® Building PAGE 19 How may we use the results in creating recommendations? Although the midpoint of the formula approach – 70% of pre-retirement net income – would require undue sacrifice in our example… …applying the more generous 80% of net income formula provides the clients with confidence and comfort that their goals will be achieved with a $96,000 annual retirement spending level. As in our first case study, the results are wide-ranging and two of the methods leave us uncertain whether the clients will attain their goals. However, once again, the approaches lead us to a solution.

20. Retirement Income Need: How Much Is Enough? ® Building PAGE 20 What May We Conclude? Determining the amount of spending during retirement – our clients’ retirement income need – depends on many factors It is NOT a cut and dried figure or approach for every client In each case, we may use information provided by the client to guide us in determining the appropriate level of retirement income need The client may wish to dictate the level of spending OR The client may wish to be guided in the process of making that determination In either case, you as an advisor must be prepared to give the best advice Using Financeware allows the advisor to quickly and easily evaluate a variety of approaches, finding the best fit and the best advice for the client

21. Retirement Income Need: How Much Is Enough? ® Building PAGE 21 Questions? Thank you, George Chamberlin gchamberlin@financeware.com (804) 644-4711 ext. 138 See the discussion of retirement income need in the two-part advisor e- mail – http://www.financeware.com/ruminations/wems/wem.10.02.02.htmlhttp://www.financeware.com/ruminations/wems/wem.10.02.02.html and http://www.financeware.com/ruminations/wems.wem/10.09.02.htmlhttp://www.financeware.com/ruminations/wems.wem/10.09.02.html