The answer to this question begins with an understanding of your day-to-day living expenses, and how those expenses may change in retirement. This is a simple enough process, although it does take some effort.
The difficult part is to determine what the funding requirement is in order to provide the income you’ll need to cover your living expenses – for as much as forty years or more!
There is a rule of thumb (more on this later) that you can use to come up with a rough guess – but without using sophisticated computer modeling and analysis, your level of assuredness is limited.
According to a recent survey by the Employee Benefits Research Institute, 84% of future retirees believe that they will have plenty of savings to cover their needs in retirement. At the same time, less than one-third of those surveyed had gone through the effort to calculate how much they will need.
When looking at the actual savings numbers, only around 20% of the survey respondents had in excess of $100,000 set aside for retirement, and more than 10% indicated that they had nothing at all saved for retirement.
The rule of thumb that I mentioned before indicates that you should plan to withdraw no more than 3% to 5% each year from your retirement savings in order to not run out of money. This is what we refer to as a “sustainable rate of withdrawal”. (There are many opinions about what exactly is the appropriate sustainable withdrawal rate – at one time it was suggested that 4% is the right number, but this has been under considerable scrutiny of late. Working with the range of 3 to 5% will get you in the ballpark, nonetheless.) This equates to a requirement of $1 million in retirement funds in order to be able to withdraw $30,000 to $50,000 each year.
Don’t despair over these estimates, though. The rule of thumb is based upon 100 percent certainty, and if you happen to have that luxury, that’s fantastic. There are ways to increase your sustainable rate of withdrawal, while still maintaining a relatively high degree of certainty.
Improving the Level of Certainty
The first and possibly most important factor is to have a plan, and to monitor your plan closely. You can do this on your own, or in conjunction with a financial pro. Paying close attention to your plan and staying with it will provide you with the information in order to make certain that your plan stays on track.
Your plan should include some sort of projections or modeling to show what your future income could be based upon your sources of income – retirement savings, pensions, Social Security, and the like. This will help you to plan for your expenses in retirement – developing a budget in reverse, if you will.
Making adjustments to your portfolio holdings can have a positive impact on the level of sustainable withdrawal. It may seem to run counter to your intuition, but more risk in your holdings is good for your long-term holdings. It is important to maintain significant positions in the stock market in order to achieve a higher level of withdrawals over time. Without some exposure to risk, your funds will fall behind when compared to inflation of day-to-day expenses, not to mention high-inflation items like healthcare costs.
The third factor that can have an impact on your savings’ sustainability is the pattern of income that you’ll need in retirement. As you probably realize, over the span of the potential forty-plus year retirement, your income needs will likely change. During your first several years, you’re likely to spend considerably more than the overall average, as you travel more, take on new hobbies, and the like. Or, on the other hand you may continue to save during this time of your life.
Later on in your retirement, many folks take on lower expenses as they become more sedentary, not traveling as much and having fewer extraneous expenses. Declining health and lower energy level makes staying closer to home more attractive. In later years, health care costs can cause those expenses to increase. It is also important to maintain a realistic view of your own life span. It’s not at all unreasonable to project your retirement plan out to your late 90’s.
There are more factors that can have a positive impact on your sustainable withdrawal rate, but these are the primary ones. I want to reiterate that the most important factor is to make a plan, monitor it closely, and make the appropriate adjustments throughout your life.
What you’ll find is that, by putting some effort into developing a plan, you’ll have much more confidence in your ability to make your savings last. At the same time, if you find that you haven’t yet done enough, you have time to make adjustments in your efforts that will increase your odds.
Having made a plan, it’s also important to review and update it, on average once a year or so. This kind of review will leave you with the peace of mind that, in fact, you’re on track.