You've saved diligently for retirement
throughout your working years, and now it's time to enjoy the fruits of your
labor. But that doesn't mean it's time to stop planning for the future. Your retirement savings will probably need to last you 20 years or more, and if you
use them up too fast, you could find yourself struggling in the final years of
your life. In order to avoid this, you need to decide on a safe withdrawal
rate.
But this is easier said than done. There are
many unknowns, including your life expectancy, investment returns, the rate of
inflation, and how much money you have saved up to begin with. All these
variables make it impossible to say with absolute certainty how much money you
can safely spend in retirement. But you can come up with an estimate. Here's a
short guide on how to do this.
The conventional wisdom
Conventional wisdom says
that you're safe to withdraw 4% of your retirement portfolio during
your first year of retirement and then adjust that amount each year to keep
pace with inflation. So if you have $1 million in savings, you would withdraw
$40,000 this year. If the inflation rate were 3%, then next year you would add
3% to that $40,000, withdrawing $41,200.
Many people like this
formula because it's simple to understand and calculate. But simple is not
always the same thing as accurate. Research from Fidelity indicates
that based on historical data, there's a 90% chance that you would have enough
money to last you through a 28-year retirement if you used a 4% withdrawal
rate. But that still leaves a 10% chance that you might not. For this reason,
some argue that it's safer to stick with a 3% withdrawal rate. Of course, if
you go this route, it's entirely possible that you could end up restricting
yourself to a lower standard of living than necessary.
An
alternative strategy
Another approach to making retirement savings
withdrawals has been proposed by the Boston College Center for Retirement
Research. It suggests using the IRS's Required Minimum Distributions (RMDs) as a guideline. RMDs are the minimum
amount that you must withdraw from your a traditional IRA or 401(k) each year
beginning at age 70 1/2. The Center for Retirement Research extrapolated from
this data to come up with a safe withdrawal rate starting at age 65.
This conservative approach is also simple to
understand, and it increases your yearly allowance as you age, which can be
helpful if you're concerned about healthcare expenses toward the end of your
life.
The drawback to this strategy is that, in the
interest of caution, you have a much lower withdrawal rate in the early years
of your retirement. This is the time when many retirees want to travel and be
active, so you may not want to restrict yourself to such a small withdrawal
amount. The researchers suggest that to deal with this issue, you withdraw all
of your interest and dividends for the year in addition to the RMD amount.
So how much can you safely withdraw?
It's impossible to say how much money you'll
need to see you through your retirement, but it's best to err on the side of
caution. The approaches listed above are a good starting point, but you may
want to adjust them to suit your lifestyle. Perhaps you want to travel for a
year or two before settling into a quiet retirement. You may need to withdraw a
little more in those years and then be more conservative in the years
following.
If you're still worried about running out of
retirement savings, it may be wise to sit down with a financial advisor, who
may be able to offer more specific advice based on your investment portfolio
and long-term goals.
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