Pete: Let’s say, hypothetically, you have $5 million laying around. Your plan for this money is twofold – save the principal to serve as an inheritance for your children and to use that same principal to generate a modest income to live off of. The goal isn’t growth, per se, but any growth could be invested in other ways or added to the principal. Here are some numbers to provide context – $5 million at 2% annually should produce $100,000. If you are currently living a lifestyle that you wish to maintain at say $60,000 per year (including taxes, etc.), Taking a 2% annual payout should provide enough income to maintain your lifestyle and have room to compensate for inflation over your remaining lifetime . Is this feasible and reasonable? – David.
Dave, can I assume you’re the one with $5 million and that you aren’t just randomly interested in me having $5 million?
Don’t get me wrong, I enjoy hypotheticals which involve me having $5 million laying around. Especially when the goals for my $5 million is to produce only 2% annually and then leave the $5 million to a party of my choosing when I head to post-retirement (death). No matter whose money it is, not only is your idea feasible and reasonable, but there are several different ways to accomplish these goals. Your challenge will be making sure you don’t lose site of your goals.
Goal #1: Produce $60,000 – $100,000 of income for the remainder of your life
I like to think of retirement income and the assets that generate it as eggs and chickens. When you retire, your assets turn into egg-laying chickens. Your goal is to live off the eggs. In Year 1 of retirement, maybe 100 eggs gets the job done. Inflation simply makes you marginally hungrier each year, which means it takes more eggs to satiate your hunger. Therefore, Year 2 requires 102 eggs or so.
If at any point your appetite surpasses your supply of eggs, cover your eyes because feathers are about to fly. Yep, Dave, time to eat a chicken. Which now means the chickens who couldn’t lay enough eggs for you this year, are now expected to lay more eggs for you next year because of inflation. That’s bad news for you and the chickens. Before you know it, all you’ll have is a pile of feathers and distant memories of omelets and chicken parmesan.
What I admire about your situation though is not only will $60,000 a year satisfy you now, but you’ve got a ton of wiggle room before you’ll need $100,000 in a year. Which means 2% returns will be just fine for you. Your chickens will lay more eggs than you initially need, and those eggs will turn into more chickens.
Goal #2: Leave your nest-egg to your children
Don’t forget, you’ve expressed a desire to leave the nest to your brood. In order to make this happen, your retirement eggs must satisfy you wholly. You’ll have no chicken dinners. However, if passing your wealth to your kids wasn’t a goal of yours, then you could be more aggressive with your retirement income goals.
This is precisely why investment objectives are so important and so personal. I don’t begrudge a person’s desire or lack of desire to leave assets to their adult children. Leaving money for dependent survivors is much different than leaving money to independent adult children. In fact, I don’t plan on leaving any assets to my children, once they’re financially independent, just as I don’t expect my parents to leave any assets to me.
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The key to your particular retirement feast, Dave, is your need for only a 2% return on your money in retirement. This is possible because you have $5 million. But it is worthing noting many people with $5 million aren’t happy with 2% returns. And beyond that, many people don’t have $5 million, so they may need much more than 2% returns or distributions. Both of these facts cause retirees to consume eggs as quickly as they’re produced.
You quickly can see how people get themselves into trouble, especially when they spend big during the first years of retirement. That’s why I like both assets dedicated to egg production (income production) and completely different assets dedicated to preventing the demise of chickens (emergency reserves).
Kudos to you, Dave. Your plan is feasible and reasonable. I hope you like eggs.
Peter Dunn is an author, speaker and radio host, and he has a free podcast: Million Dollar Plan. Have a question about money for Pete the Planner? Email him at [email protected].