For many people, the COVID-19 pandemic has been a wakeup call. Few people have said at the end of their lives, “I wish I spent more time at the office.” You may have clients who are wondering whether they can retire early. You may have others who are in great financial shape, making you wonder why they’re still working. Let’s explore these questions further. For accountants and managers, these questions can be viewed like a decision tree: Is their early retirement your idea or theirs? If it’s their idea, can they afford to retire: Now? Soon? Later? Never?
What Would Retirement Look Like?
Some people imagine retirement through the lens of classic TV series. There, retirees seem to have unlimited income, playing golf, dining out and taking multiple vacations. At the other end of the spectrum, an underfunded retirement can resemble the pandemic lockdown. Look back on the previous year: If you stayed at home and didn’t travel or dine out, that’s what retirement will look like if your client has barely enough to get by, with no disposable income.
What Would Retirement Cost?
Some people think that no longer needing to dry clean suits or buy lunch in the city will dramatically reduce their expenses in retirement. The reality is that a person’s post-retirement lifestyle expenses may be about 80 percent of their pre-retirement expenses. Income will generally come from three sources: regular payments like Social Security (plus annuities and defined benefit pensions), income generated through retirement assets (and taxable assets) and, perhaps, a part-time job on the side.
Your client needs to determine what 80 percent of their current expenses is and then compare that to their income from Social Security and other defined payments. There will likely be a shortfall. They need to consider their income-producing assets as a pool. How much could they generate? They should be looking at four to five percent as a realistic number.
Your client likely won’t want to take on a part-time job, especially if the job is retail or fast food. However, a part-time job is worth considering if the income gap is significant.
As an accounting professional, you can guide them through this process. Retirement planning is a key element in the financial planning process.
Can Your Client Retire Now, Soon, Later or Never?
Let’s return to the decision tree. Perhaps your client is still working even though they are in great financial shape. Maybe they love their job, it’s not stressful or their income is spectacular, giving them no cause to leave. Maybe they own the company and would need to sell it if they wanted to retire. In all these cases, they are actively choosing to keep working.
Can they retire now? Perhaps one reason they are still working is because they didn’t know they were in a position to retire and live off their retirement benefits and investment income! I once had the pleasure of having this conversation with a client during her annual portfolio review. After listening to her talk about how much she disliked her job, I explained that if her assets were redirected from growth toward income, based on her spending over the last few years, she could quit her job tomorrow. (She didn’t; she gave two weeks’ notice.)
Can they retire soon? Perhaps your client has initiated this conversation, and they are contributing to their retirement accounts. Retirement planning software can help with forecasting. You can conservatively project asset growth while anticipating that their expenses will rise in line with inflation. You can also run Monte Carlo analyses showing likely and extreme scenarios to see how long their money would last and whether they would leave a significant residual at age 100 or run out of money. Based on these analyses, your client might determine that they could retire in a couple of years.
Can they retire later? The previous two scenarios are very optimistic. In reality, many Americans are unprepared for retirement. You might run calculations and show, based on your client’s chosen retirement age, that there will be a shortfall. Now, we have another decision tree. Your client can work longer, delaying retirement, choose to live on less income in retirement or increase their savings dramatically. You might advise them to contribute as much as possible to every retirement vehicle they are allowed. IRA and 401(k) contributions will reduce their taxable income, and the growth in those accounts is tax deferred. If they are able to live on their salaries, they should bank any annual bonuses they receive.
Can they never retire? This sounds grim, but you should be prepared to have this conversation. If your client wants to retire early and they have $100,000 put away, yet they spend $80,000 a year, the numbers won’t add up. If you have this discussion, look at other ways to increase their income-producing assets to close the gap. Perhaps they can reduce their living expenses by forgoing vacations and having fewer dinners out. This might resemble the pandemic lockdown lifestyle. If they own a second home, consider whether it could be sold and the assets could be used to generate additional income. Perhaps your client would consider downsizing, selling their home and moving to a state with a lower cost of living. Senior living communities are everywhere. If your client will potentially receive an inheritance from their parents, this could eventually be a windfall, although your client should be aware that their parents might spend their assets on the costs of living.
Regardless of whether you initiated the conversation about early retirement or your client did, there are several directions this conversation could take. You can be prepared to address all of the scenarios and offer guidance on the best one.