How much can you spend without running out of money in retirement?
- Anatoly Iofe
- Sep 2, 2024
- 7 min read
Retirement is an exciting phase of life, but it also comes with one crucial question: how do you ensure that your savings last as long as you do? After years of hard work and careful saving, the last thing you want is to outlive your money. The key lies in figuring out how much you can safely withdraw each year without depleting your savings.
One of the most popular guidelines for determining this amount is the 4% rule. While it’s a useful starting point, it’s not a one-size-fits-all solution. In this article, we'll explore the 4% rule, discuss its limitations, and guide you on how to create a personalized spending plan that fits your unique retirement needs.
What is the 4% rule?
The 4% rule is a straightforward guideline that helps retirees determine how much they can withdraw from their savings each year without running out of money. The idea is simple: in your first year of retirement, you withdraw 4% of your total investment portfolio. In each subsequent year, you adjust that amount for inflation.
For example, if you retire with a $1 million portfolio, the 4% rule suggests you should withdraw $40,000 in your first year. If inflation is 2%, you would then increase your withdrawal to $40,800 in the second year, and so on. The goal is to help you manage your savings over a 30-year retirement period without running out of money.
The 4% rule: a starting point, not a destination
While the 4% rule is widely used, it’s important to understand its limitations. Retirement is a dynamic phase of life, and a rigid rule might not account for the complexities and uncertainties that come with it. Here’s why the 4% rule might not be perfect for everyone:
Flexibility is key
The 4% rule assumes a fixed spending pattern, increasing your withdrawals each year only by the rate of inflation. However, life in retirement is rarely so predictable. You might encounter unexpected expenses, such as healthcare costs, or you may want to spend more on travel or hobbies in your early retirement years. Conversely, there may be years when you spend less.
By incorporating flexibility into your spending plan, you can adapt to life’s uncertainties and make your money last longer. For instance, during a market downturn, you might choose to reduce withdrawals to preserve your investments. Conversely, in a strong market, you might afford to spend a bit more on luxuries or experiences you enjoy.
Portfolio composition matters
The 4% rule is based on a balanced portfolio consisting of 50% stocks and 50% bonds. However, your actual investment mix might differ. If you have a more aggressive portfolio with a higher percentage of stocks, your potential for growth—and volatility—will be greater. On the other hand, a more conservative portfolio, heavy on bonds, might offer stability but lower long-term returns.
Your withdrawal rate should reflect your specific investment mix. A diversified portfolio that includes stocks, bonds, and cash allows you to balance growth potential with stability. The key is to align your asset allocation with your risk tolerance and investment goals, knowing that your portfolio may need to evolve as you progress through retirement.
Market returns aren’t guaranteed
The 4% rule is based on historical market returns, but the future doesn’t always mirror the past. According to projections by Charles Schwab Investment Management, future returns for both stocks and bonds could be lower than the long-term averages. This means that if you rely strictly on the 4% rule, you might risk running out of money sooner than expected.
To navigate this uncertainty, it’s essential to regularly revisit your spending strategy and adjust it based on current market conditions. This proactive approach can help protect your savings in an unpredictable economic environment.
Life expectancy varies
The 4% rule assumes a 30-year retirement, but everyone’s situation is different. According to the Social Security Administration, the average life expectancy for a 65-year-old today is less than 30 years, though many people will live longer. Planning for a longer retirement is wise, especially if you’re in good health or have a family history of longevity.
For those retiring earlier or expecting to live longer, a more conservative withdrawal rate might be necessary. Conversely, if you retire later or have other sources of income, such as Social Security or a pension, you might afford a higher withdrawal rate.
The erosion of purchasing power: the impact of inflation
Inflation is an invisible force that can slowly erode your purchasing power over time. While it might seem minor year-to-year, inflation can significantly impact your retirement income over the long term. What costs $1,000 today could cost much more in the future, which means that your withdrawals need to account for this rising cost of living.
Inflation impacts different spending categories in various ways. For example, healthcare costs tend to rise faster than the general inflation rate, which can be particularly challenging for retirees. Meanwhile, some fixed expenses, like a mortgage payment, might stay the same, but the cost of everyday items like groceries and utilities will likely go up.
To protect against inflation, consider investments that have the potential to outpace it, such as stocks or inflation-protected securities. Additionally, regularly updating your spending plan to account for inflation will help ensure that your retirement income continues to meet your needs.
Crafting a personalized spending plan
Given the complexities of retirement spending, how can you create a personalized withdrawal rate that suits your unique circumstances? Here are four key questions to guide you:
How long do you need your money to last?
Your planning horizon is a crucial factor in determining your withdrawal strategy. While no one can predict exactly how long they’ll live, you can estimate based on your health, family history, and other personal factors. Tools like the Social Security Administration's life expectancy calculator can provide a general idea.
If you’re particularly concerned about outliving your assets, you might opt for a more conservative approach, planning for a longer time horizon or a lower withdrawal rate. Conversely, if you have other income sources, such as a pension or annuities, you might be comfortable with a shorter planning period and a higher withdrawal rate.
How will you invest your retirement savings?
Your asset allocation plays a significant role in determining a sustainable withdrawal rate. Stocks offer growth potential that can help your portfolio keep pace with inflation, while bonds and cash provide stability and income. Finding the right mix depends on your risk tolerance, investment goals, and how long you expect your retirement to last.
An aggressive portfolio may allow for higher withdrawals in the early years of retirement, but it also comes with the risk of greater losses in down markets. Conversely, a conservative portfolio may limit your withdrawals but provide more stability. The key is to find an asset mix that you’re comfortable with, knowing that your portfolio may need adjustments over time.
What level of confidence do you want that your money will last?
Confidence level refers to the likelihood that your portfolio will not run out of money during your retirement, based on different market scenarios. For example, a 90% confidence level suggests that in 90% of projections, your money would last throughout your retirement.
While aiming for a high confidence level might bring peace of mind, it often requires a lower spending rate. On the other hand, a lower confidence level might allow you to spend more, with the understanding that you may need to adjust if the market doesn’t perform as expected. Many retirees find that a confidence level between 75% and 90% offers a good balance, allowing for comfortable spending without excessive worry.
Will you adjust your spending as circumstances change?
One of the most important aspects of retirement planning is the ability to adapt. The 4% rule assumes a steady withdrawal pattern, but real life is more fluid. If market conditions change, or if your personal situation evolves, being willing to adjust your spending can significantly enhance the longevity of your portfolio.
For example, if the market takes a downturn early in your retirement, reducing your withdrawals can help preserve your portfolio. Conversely, in a strong market, you might afford to spend a bit more on things you enjoy. Regularly reviewing and adjusting your spending plan is key to ensuring your money lasts as long as you do.
Bringing it all together: a personalized strategy
Once you’ve considered these factors, how do you put them into a cohesive plan? Here’s a basic outline to help guide you:
Set an initial withdrawal rate: Start by determining an initial withdrawal rate that balances your need for income with the longevity of your portfolio, considering your asset allocation, risk tolerance, and planning horizon.
Adjust annually: Each year, adjust your withdrawal amount for inflation and market performance. Be prepared to make bigger adjustments if there are significant changes in your portfolio or personal circumstances.
Regularly review your plan: At least once a year, sit down with a financial advisor to review your plan. This review should consider changes in the economy, your health, and other factors that might impact your retirement spending.
Prepare for the unexpected: Have a contingency plan for unexpected events, such as a market downturn or significant health expenses. This might involve cutting back on discretionary spending, downsizing, or tapping into other resources.
Taxes and fees: the hidden costs
When calculating your retirement withdrawals, don’t overlook taxes and investment fees. These costs can take a significant bite out of your retirement income if not properly accounted for. The 4% rule doesn’t consider these expenses, so you’ll need to factor them into your spending plan.
Be mindful of the impact of taxes on your withdrawals, especially if you’re taking money from tax-deferred accounts like a 401(k) or traditional IRA. Planning for these expenses can help you avoid unpleasant surprises and ensure that you’re not withdrawing more than necessary.
Stay flexible—prepare for the unexpected
Retirement planning is not a set-it-and-forget-it process. The original 4% rule assumes you’ll increase your spending by the rate of inflation each year, regardless of market performance. But life is unpredictable, and it pays to stay flexible. If the market takes a hit, you might choose to hold off on increasing your spending or even reduce it. Conversely, if the market performs well, you might decide to enjoy a few extra luxuries.
The bottom line is that retirement planning isn’t about rigid rules or complicated calculations—it’s about enjoying your retirement with peace of mind. By having a plan, staying flexible, and regularly reviewing your strategy, you can strike the right balance between spending and saving, ensuring that your retirement years are truly golden.
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Sources*:
*These organizations are not affiliated with IFG. IFG does not endorse, support, or recommend any information that is not provided by its affiliates or representatives.
Disclaimer:
Information provided is for informational purposes only, and does not constitute an offer or solicitation to sell, a solicitation of an offer to buy, any security or any other product or service. Accordingly, this document does not constitute investment advice or counsel or solicitation for investment in any security. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
