How Not to Run Out of Money in Retirement
How much do you need for retirement? That’s a question we all ask ourselves. The answer is dependent on your individual circumstances, but it’s also important to get informed guidance on the matter.
The two key pieces of information you need are 1) What is your expected cost of living? and 2) What are your total sources of income? The latter can include pensions and Social Security.
Then you need to figure out the difference between 1 and 2.
A recent report found that the average American retires at age 63 and lives until 79. Consequently, on “average” we should plan to spend 16 years in retirement. Of course you should play it a little safe, because you don’t want to run out of money before you run out of retirement. That same study found that a million dollars could last anywhere from 12 years (in Hawaii) to 26 years (in Mississippi).
These scenarios depend on how much of your savings you withdraw each year. Because the average annual return of a balanced portfolio has historically been about 7.5%, many financial planners have suggested that you can safely withdraw 6%-7% each year.
Do the math…
William Bengen, an MIT graduate and certified financial planner, disputes that notion. He did the math to back up his assertion.
Bengen looked at historical market returns and concluded that the higher withdrawal rates ignored the impact of bear markets, which can devastate portfolios if they happen early in retirement.
Bengen back-tested portfolios using historical returns for some of the worst bear markets. His recommended portfolio allocation was 50% stocks and 50% cash and bonds.
Bengen concluded that retirees could safely withdraw 4% from their retirement accounts in the first year of retirement, and then increase that each year according to the previous year’s inflation rate. A portfolio using this strategy has been calculated to last for at least 50 years 70% of the time, and in the worst case it would have still lasted 29 years.
Some may find this rule unnecessarily conservative, but you could always increase your withdrawals if you find that your portfolio is continuing to build. In any case, if you apply Bengen’s rule, then in the first year of retirement you could reasonably withdraw $40,000 for every $1 million you have in your retirement portfolio.
Once you have a good idea of your expected spending, you need to determine whether your withdrawal, combined with Social Security benefits, pensions, and any other source of income will be enough to meet your budget.
Otherwise, it’s time to pick up your savings rate and perhaps rethink your investment strategy. Or you could always put your surfboard in storage and move to Mississippi.