Nearly everyone looks forward to retirement— that time in your life when you have more time for the things you enjoy, and you don’t need to devote hours every day working for someone else. It’s no wonder that retirement is considered the “golden years” of your life.
What’s less clear, however, is how to pay for it.
Paying for Your Retirement
If you’ve been steadily squirreling away money for retirement, you might think that you don’t have much to worry about. After all, the lump sum on your retirement account statements looks like more than enough money to get you through the rest of your life.
But is it really?
Lifespans globally continue to increase, which means many workers are living longer into their retirements.
And even if you plan to work into your 70s, chances are that you’ll remain active and ready to tackle all those things you couldn’t take advantage of when working 40+ hours a week. Traveling, purchasing a second home, and fully immersing yourself in your hobbies are a few common retirement aspirations.
Determining how much to withdraw from savings in order to enjoy your new found activities while having enough to pay for all the things you want to accomplish is not an easy equation. The withdrawal amount depends partly on how much money you saved, along with how much money you’ll need, and for how long.
Most retirees want to maintain their current lifestyle during retirement. Some will opt to trade commuting costs and work wardrobe expenses for hobby equipment and travel. And you can always manage your variable costs, like how much you want to spend on your next trip, or if you are going to purchase that new stand up paddle board. Often people will spend less if they are worried about how long the money needs to last.
That “how long” can certainly make the math tricky. If your portfolio isn’t allocated correctly the market value can fluctuate too much; and all of a sudden, your monthly or annual withdrawal amount has a much bigger impact on the “how long” will the money last.
Influences on the Amount You Can Withdraw
If there’s one thing that can be said about investments, it’s that they always seem to change. While it can be difficult to predict how much money you’re actually able to withdraw from savings, there are some definite things that can influence it.
Fixed Income to Equities Proportion
As always, the ratio of fixed income (or bonds) to equities is based on several factors. Keep the following in mind: including equities in your portfolio can provide a growth element that helps the market value keep up with inflation, allowing the account value to support your annual withdrawal. You should aim to have at least some larger portion of your retirement portfolio in equities. However there is such a thing as “too much” in equities, so it’s best to work with an advisor to determine what the right amount is for your portfolio.
Conversely, tying up too much money in low-yielding fixed income investment vehicles (bonds) leaves you open to running out of money. This is because your portfolio may not keep up with inflation and therefore fail to support your annual withdrawal.
Diversification is Key
A well-managed retirement portfolio has a diverse mix of stocks, bonds, and other assets. The exact mix will depend on a number of factors, including your reaction to risk, the amount of money you started with, and the amount you need to live comfortably each year.
Analyzing the performance of your retirement portfolio and rebalancing it to meet your needs is necessary on a regular basis.
Flexibility Must Be Built In
Just as in your working life, there are going to be times when your expenses will be higher than anticipated. Even the best plans need to include options for life’s surprises— whether those are market corrections or personal needs. During those years when your portfolio experiences growth, you can potentially withdraw more. And adopting a spending policy early in your retirement can help when surprises occur.
What is the “4% Rule”?
During the early 1990s, a financial advisor by the name of Bill Bengen devised the “4% rule.” This rule states that if you withdraw 4.5% of your retirement income (from all sources) every year, then you should have enough money to pay for 30 years of living expenses (as long as that 4.5% is adjusted for inflation).
This simple rule makes it seem like calculating the withdrawal from your retirement account is easy and automatic, but a one-size-fits-all approach likely won’t work for everyone all the time.
It’s best to use the 4% rule as a guide when creating your own spending policy. Several factors go into creating a spending policy, like expected rates of return of your asset allocation, your life expectancy (that “how long” mentioned above), as well as how much you need to meet your needs.