NET WORTH AND DEBT RATIOS AT RETIREMENT
As many begin to prepare for retirement they learn the complexities of ensuring that your hard work during your “growth” or “working” years can be preserved throughout retirement. Some financial health indicators, such as net worth and debt-to-income ratios, can help to formulate a plan.
Retirement is often spoken of in dollar terms, ie. “you need $1 million to retire”. However, when retirement is looming it is most important your nest egg covers your costs of living, while also ensuring it can fund your retirement goals, such as travel, charitable contributions, inheritances, and gifts to your loved ones and organizations. The challenge, of course, is budgeting all of these goals and expenses, with the uncertainty of the duration of each retiree’s lifetime remaining. We can research life expectancies, which greatly differ depending on the source, and learn that the average American lives to approximately 79 years old in 2020!
These ratios, however, are a great starting point for evaluating your financial health and situation. One of the most valuable, debt to income, compares your gross monthly income to your monthly debt. This can be calculated by taking your monthly debt payments/monthly income. For example, if all your debt payments (car, house, credit cards, etc) account for $2,000 of your monthly payments, while your income is $5,000 per month ($60,000/yr) your debt-to-income ratio would be 0.4, or 40% as often expressed. Calculators, such as this, can help you generate your ratio. Obviously, the smaller the ratio/percentage the better, but many, including Schwab, recommends the “28/36 rule” during your working or “accumulation” years, and to ultimarely minimize your debt-to-income ratio as much as possible, even recommending a HELOC to pay down debt, if applicable.
Debt-to-income ratios, however, aren’t the end all be all. For instance, a mortgage can be “good debt”, if its value is increasing and you’re maximizing homeowner tax credits, whereas a new Cadillac would fall into “bad debt” as its value will rapidly decrease over the life of the loan. So, ratios do not translate perfectly for financial health, but rather a starting point.
Net worth, which you can calculate with the help of this calculator, can also help you to begin assessing your nest egg for retirement, however, you must be cautious as assets, such as your home, vehicles, or collectibles, do not generate income and often actually require expenses to maintain. The most important assets for a retiree are assets that are held in investment instruments, such as IRAs, Certificates of Deposit (CDs), bonds, and the like. These are assets that are generating income and growing alongside the market. Even assets such as homes and collectibles could be of great value, however, they are far less liquid of assets and could face significant maintenance costs (insurance or repair) or depreciation (due to consumer preferences). Further, assets, such as homes, can only be accessed if sold, which leaves the owner without shelter and accumulates further expenses such as moving and financial fees.
However, a basic rule of thumb, for net worth, is to have reached 20x your annual spending in net worth by age 72. This provides you the freedom, and flexibility, while spending less than 5% of your net worth annually, which, historically, with a well balanced portfolio, minimizes loss of net worth year over year. This enables you to live long into your 90s, and even beyond, without anxiety of “running out of money”, while also ensuring your wealth can be donated or passed on to your loved ones and charitable organizations you worked hard to support during your lifetime.
Financial Indicators as Guidelines in Retirement
No matter your calculations or personal financial situation these indicators should all be taken as guidelines, rather than defining your retirement. Ultimately, meeting with teams of financial professionals and wealth managers, such as KCA Wealth Management, is essential in ensuring you will have enough in retirement to not only “survive” financially, but prosper and reach all of your goals!
At KCA Wealth Management our mission is to be there every step of the way in supporting the members of our community with the financial and educational resources they need and deserve to prosper in retirement.