How much of my retirement savings can I spend in retirement so I don’t run out of money?
Last week, I discussed how to save the big money you will need to live comfortably in retirement, especially if you don’t have a pension. Now let’s turn to spending your retirement savings which can be as confusing as saving for retirement. Hopefully, you have saved a GIGANTIC pile of money in your tax-advantaged retirement accounts before you are ready or have to retire. Once you retire, managing your retirement savings becomes even more challenging because you have to balance the need for immediate cash withdrawals versus your long-term need to make your savings last for as long as you live. You have the challenge to make it last for perhaps 30 years or more, while guarding against stock market crashes, failure to keep pace with inflation, and spending it too fast. Let’s discuss several strategies to manage your retirement savings withdrawals.
The first priority is to make whatever amount you have managed to save, last for the rest of your life, plus your spouse’s. For many people, this could mean 30 years or more, especially if one spouse is much younger. Statistically, a male aged 65 at retirement could live another 19+ years and a female, 21+ years. Of course this actually depends upon many factors such as health, genes, exercise, smoking, eating habits, etc., so many people will live much longer. This means that you will need to limit the amount you withdraw and spend, while continuing to manage your investments so they continue to grow. Therefore, the amount you can withdraw from your savings is NOT the amount you think you “need”, but rather is based upon a calculation that increases the likelihood that your savings will last your lifetime plus spouse’s. You need a strategy to accomplish this and we will look at several.
1. Market adjusted withdrawals
2. 4% + inflation rule
3. Age divided by 20
The question is how much of your retirement savings can you withdraw each year to live on, i.e., how to manage your retirement savings withdrawals?
Market adjusted withdrawals
The first approach is to adjust your standard of living based upon how well your investments did the previous year. This will help ensure your savings last, but can be a real challenge in those years when your investments did poorly. Moreover, living on dividends is a real challenge during periods like now when rates are really, really low.
4% + inflation rule
The “4%” rule advises retirees to withdraw 4% of their retirement savings balance during their first year in retirement and even allows us to increase it each following year by the rate of inflation. Both academic research and widespread practice suggests that this withdrawal strategy makes it at least 90% likely that most people will have enough savings to last their lifetime. But it doesn’t guarantee it, since many factors can influence success including your actual life span, severity of market downturns, extent of low interest rate periods, how aggressively you invest your savings, and your withdrawal rate and strategy.
Calculating your first year’s withdrawal is easy. Let’s make it simple by using a retirement savings balance of $100,000 which you can extrapolate to your own level:
$100,000 x 0.04 = $4000 annually / 12 = $333 monthly.
In year two, you get to increase that by the rate of inflation, let’s say 3%:
$4000 + ($4000 * .03 = $120) = $4120 annually / 12 = $343 monthly.
In year three, let’s say inflation is 2.5%:
$4120 + ($4120 * .025 = $103) = $4223 annually / 12 = $351 monthly.
The 4% rule is the most well known retirement withdrawal strategy, but has criticisms including that it doesn’t account for years when the market does really bad and can be hard to apply inflation increases in real life.
Age Divided by 20
The “age divided by 20” is a much newer strategy. You divide your age by 20 and the result is the percentage of your savings you can spend that year. This is easy to calculate and automatically increases each year. Criticisms include not accounting for market swings and possibly being too conservative, and thus lowering your standard of living unnecessarily.
Additional retirement spending considerations
Regardless of the strategy you choose, consider these additional situations. You can likely spend more from savings if you have long-term care insurance, pensions, or the market and interest rates do well. Spend less if you want to leave money to children/charity, or one spouse will lose a lot of income when the partner dies.
Regardless of the strategy you use to determine the amount of savings you can withdraw each year for income, you can add flexibility based upon your changing needs, market performance, and impending debt payoffs. But always keep in mind the need to make your savings last for both yours and your spouse’s life times. You may need to withdraw more in certain years to pay for unusual expenses such as a vacation, new car, or new roof. Ideally they can be timed with good market performance years. On the other hand, these expensive years should be balanced by lower withdrawals later or during bad market performance years. In particular, when you need to protect your savings balance, consider skipping your usual increase for inflation. If your savings have taken a big hit from an extended market downturn, you may even have years when it is necessary to live more frugally and withdraw less. This is especially true if the downturn occurs at the beginning of your retirement since big withdrawals, combined with a down market early in your retirement, can be hard to recover from and decreases the chances that you will outlive your savings. Another consideration is to time your retirement savings withdrawal amounts to your pending debt payoffs. If debts such as a mortgage or student loans will be paid off within a few years, it’s fine to withdraw more in your initial years with the expectation to cut back accordingly when debts are paid off and your expenses will be lower.
Next time, I’ll discuss a safe way to manage your retirement savings withdrawals regardless of how much you decide to withdraw and spend.