How Much Will You Need To Retire? (Part One)

February 2015
Personal Finances Budgeting, Spending, Saving

The most common question we hear from doctors is: “How much will I need to retire and when can I expect to get there?” The asset value required for a doctor to comfortably retire depends on several factors, including his age at retirement, assumed investment return, projected life expectancy, and effective tax rate in retirement.

However, the most critical factor is the doctor’s spending level in retirement. Believe it or not, many doctors are stunned to learn that if they are planning to spend $20,000 a month (after taxes) in retirement, they will need exactly twice the available investment assets than if they spend only $10,000 a month (after taxes).

Tracking Current Personal Spending

The first step in the process is for the doctor to accurately determine his current personal spending level. Surprisingly, barely more than half of doctors know this figure with any degree of certainty, while the rest are flying blind. Planning your finances without accurately knowing your spending level is akin to doing dentistry without taking X-rays - - extremely dangerous!

Most doctors have now computerized their personal finances and use Quicken or to track their annual spending. These doctors can easily run a summary of their personal living expenses for the last 12 months, delete any major non-recurring items, and divide by 12 to arrive at a monthly spending figure. Non-computerized doctors can achieve the same result by reconstructing their personal spending over the last 12 months through manually recording expenses from their canceled checks, bank, and credit card statements.

Comparing Current and Retirement Spending

Years ago, we estimated how much doctors needed to accumulate to retire based on the doctor’s current spending level. Unfortunately, we found that the approach sometimes produced inaccurate results. In reality, it’s what the doctor will spend in retirement that matters, and not what he or she is spending now.

Many financial advisors rely on a standard “rule of thumb” that doctors will spend only 70-80% of their current spending level when retired. We’ve helped hundreds of doctors reach financial independence and the reality is that most (over 90%) ended up spending just as much in retirement, as before.

That’s especially true during the first 7-10 years of retirement, when doctors are picking up new hobbies, increasing their travel, eating out more often, pursuing additional education, and spending more money on their grandchildren. Moreover, many doctors underestimate their expected health care expenses in retirement, which averages $220,000 according to a 2014 Fidelity Investments survey. Inflation also boosts doctors’ spending in retirement.

Did you know doctors spend more money on Saturday than any other day of the week? That’s simply because they have more time. Be forewarned – in retirement, every day is Saturday!

Projected Spending in Retirement

While a rule of thumb is helpful, doctors need to know what their spending will look like in retirement based upon their own unique situation. To calculate this, start with the doctor’s current spending level and reduce it by expenses that will disappear in retirement. This includes home mortgage (first home, second home, home equity line) and other debt payments that will be paid off, children’s expenses such as education, cell phone, auto, etc. that will be eliminated, and premiums for life, disability, long-term care, and other coverages that will not be needed in retirement.

Other expenses will likely be reduced but not eliminated in retirement. For example, doctors who make sizable charitable contributions during their high income earning years will likely continue contributing, but at a reduced level (but likely the same percentage of income) during their lower income retirement years.

Also, some (around 20-25%) doctors will actually sell their personal residence and downsize in retirement. The mortgage on their current home will be paid off upon the sale, and often there’s enough cash equity left over to purchase a smaller home/townhome with no mortgage debt. As an added bonus, property taxes, utilities, fire and hazard insurance, and repairs and maintenance on the new residence will likely be reduced by thousands of dollars a year.

Add Back Elective Expenses

Many doctors end their projected retirement spending analysis there, which is a grave error. They commonly overlook the substantial amount of practice-paid benefits (or elective expenses) that will be paid out of the doctor’s pocket in retirement. These perks often add up to thousands of dollars a month and include auto payments, auto expenses, health insurance, medical reimbursement, travel, meals and entertainment, uniform/clothing, dues and subscriptions, furniture/artwork, supplies, cell and home telephone, cable and internet, and various other expenses. Only after these expenses are added back does the doctor have a realistic picture of his anticipated spending in retirement.

Involve Your Spouse

As you can see, this calculation is somewhat involved. Don’t try this alone! Retirement represents one of the biggest changes in your relationship with your spouse. There are so many decisions involved, particularly with a home sale/downsizing that you need to involve your spouse completely in the process, so the two of you arrive at a mutually agreeable decision. Many doctors who sought to go it alone have had their best laid plans vetoed over the dinner table, ending back at square one. And it’s best to involve a third party financial advisor who can facilitate the process and minimize or eliminate spousal conflict that can have a detrimental long-term effect on your relationship.

Reality Check

Once you and your spouse have agreed on a projected monthly spending level in retirement, it’s time for a reality check. For our investment clients, we simply wire the agreed upon amount into their checking account on the first day of each month in retirement. When the money’s gone, it’s time to stop spending. You need to make sure that the end of the month comes before the end of the money. So ask yourself, “Can we realistically commit to live off this amount each month?”

Because the stakes are so high, you need to make sure your financial analysis is increasingly accurate as you approach retirement. Once you sell your practice and sign a related non-compete, it’s extremely difficult to go back into practice to generate income once again. So don’t come up short and have to spend your retirement years as a Walmart greeter!

In Part Two, we’ll help you determine how much you will need to accumulate based on your calculated spending level in order to maintain or improve your lifestyle in retirement, and how to track your progress toward achieving that goal.

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