Retirement seems to be on a lot of readers' minds these days, and one of the more common questions I'm receiving is, “How will I know when I've accumulated enough money to safely retire?”
It's good that more physicians are turning their attention to this issue, because the road to retirement is fraught with many challenges.
The most common mistake made by physicians and other professionals is saving too little. We either never calculate or we underestimate how much we'll need to last through retirement.
We also tend to live longer than planned. As life expectancy increases, we run the risk of outliving our savings. And we don't face facts about long-term care. Not nearly enough of us have long-term-care insurance, or the means to self-fund an extended long-term-care situation.
Many people lack a clear idea of where their retirement income will come from, and even when they do, they don't know how to manage their savings correctly. Physicians in particular are notorious for not understanding investments. Many attempt to manage their practice's retirement plans with inadequate knowledge of how the investments within their plans work. Seeking the guidance of a qualified financial professional is often a far better strategy.
So, how will you know when you can safely retire? As with everything else, it depends. To arrive at any sort of reliable ballpark figure, you'll need to know three things: how much you realistically expect to spend annually after retirement, how much principal you'll need to generate that annual income, and how far your present savings are from that figure.
According to one oft-quoted rule of thumb, in retirement you should plan to spend about 70% of what you're spending now. That's nonsense. A few significant expenses, such as disability and malpractice insurance premiums, will be eliminated, but other expenses, such as travel, recreation, and medical care (including long-term-care insurance), will increase.
My wife and I are assuming we will spend about the same in retirement as we spend now, and I suggest you do, too.
Once you have an estimate of your annual retirement expenses, you'll need to determine how much you'll need—usually in fixed pensions and invested assets—to generate that income. Social Security can be included, if you're over 50. If you're younger, don't count on receiving any entitlements since no one can predict how they will fare in coming generations.
Most financial advisors use the 5% rule: Assume the best you'll do on your money is 5% a year. So if your annual retirement expense estimate is $100,000, you'll need $2 million in assets. If you want to spend $200,000 per year, you'll need $4 million. That rule has worked well in most years, allowing for reasonable taxes, inflation, and rates of return.
How do you accumulate that kind of money? Financial experts say that too many physicians invest too aggressively. For retirement, safety is the key. The most foolproof strategy—seldom employed, because it's boring—is to sock away a fixed amount per month (after your retirement plan has been funded) in a mutual fund. With the power of compounded interest working for you, $1,000 per month for 25 years with the market earning 10% overall comes to almost $2 million.
Of course, it goes without saying that debt can destroy the best-laid retirement plans. If you carry significant debt, pay it off as soon as possible.
For those of you who are early in your careers, it is never too soon to think about retirement. Young physicians often defer contributing to their retirement plans because they want to save for a new house or for college for their children. There are tangible tax benefits that you get now, though, because your contributions usually reduce your taxable income and your investment grows tax free until you take it out.
No matter what your age, it's hard to motivate yourself to save for retirement because it generally requires spending less money now. You can always pay a financial planner to help you get organized, but you still must motivate yourself to change and follow the planner's advice.
In the end, the strategy is very straightforward: Put as much money as you can in a tax-deductible retirement plan, let it stay there and grow tax deferred until you take it out, and invest for the long term with your target amount in mind. It really is that simple.