Last week, in this blog series, we examined the individual nature of establishing personal retirement income goals. There is no “magic bullet” number for accumulation of wealth prior to retirement. Everyone has an idea of the income they will need to live throughout retirement. Rather than targeting a preset amount of money in retirement accounts, we concentrate on sources of retirement income in order to arrive at an income-based goal.
Retirees will likely not be totally dependent on their savings in order to fund retirement. Most Americans will have Social Security benefits, and in addition, lesser numbers of people will have some combination of private pensions, public pensions, and private annuities. In each generation, many people will inherit wealth from parents and other relatives.
Once a desired income goal is agreed upon, all income sources are aggregated toward that goal. The difference (assuming it is a shortage) must be made up from savings (in both retirement and non-qualified accounts). It is generally not critical for income planning to have retirement assets of sufficient quantity to fund a complete retirement.
It is now time to introduce the concept of “Equivalent Net Worth,” or “ENW.” ENW is an intangible sum of money that works for you by supplying lifetime income, but you do not actually own the cash. For example, an income stream produced from a pension or annuity (Social Security qualifies as an annuity) has value, but you cannot actually touch the funds that produce the income.
Under this formula, Social Security recipients have an ENW based on their benefit level when they file. The ENW formula is based on the concept of a “safe withdrawal rate” of 4%. This means that a saver should be able to withdraw 4% of the balance from investment accounts annually, and still outlive the money. Calculating the amount of money needed simply uses the reciprocal of the withdrawal rate. This is done by multiplying annual cash income by 25.
Under this formula, every $10,000 of needed annual retirement income would require either a savings, or ENW, of $250,000 ($10,000 annually times 25). Today’s average Social Security benefit is $17,532 annually, the ENW of these recipients is $438,300 (25 times $17,532). Married couples have an even larger ENW, as spouses can collect from the other spouse’s Social Security account.
Having the above sum of $438,300 in cash will produce the same income as the Social Security payment. A saver with that much cash has a Net Worth (NW) that includes the base sum of $438,300. When the saver dies, his or her heirs will inherit the money in the account. However, when the Social Security recipient dies, the heirs have no cash to inherit. It is intangible, and therefore included as Equivalent Net Worth (ENW). The income stream is something of value, and reduces the need of the saver to reach a difficult savings goal.
A recent Charles Schwab & Co. survey revealed that the average targeted retirement savings for Americans is $1.7 Million. While very few people will ever save that much, the concept of Equivalent Net Worth tells us that we are more likely to reach our retirement income goals with a lesser savings goal. This observation should come as a relief to savers and investors.
According to the U.S. Bureau of Labor Statistics (bls.gov), only 3% of private-sector employees have pension benefits. These fortunate few often receive more than $50,000 annually, which has an ENW of $1,250,000. We often say that there 2 types of people in the country; those who have pensions, and those who wish they did. The numbers illustrate why. However, non-pensioners have other means of producing retirement income. In many cases, they are wealthier than they thought.
Retirement income planning can be confusing, and we can assist anyone desiring eventual financial independence.
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