As a financial advisor, one of the most common worries I hear is the fear of outliving your savings. In fact, an AARP survey found that 61% of Americans are worried about running out of money during retirement.
This is no surprise, since inflation rates, longevity risk, and unexpected medical needs are unknowns that can greatly impact how far your nest egg will stretch. And while the temptation to hoard every penny of your retirement savings may make it last longer, it will also rob you of joy during a season you’ve been looking forward to.
Instead of crossing your fingers and hoping you have enough or letting fear take over your retirement, let’s look at how to identify and plan for a sustainable withdrawal rate that fits your lifestyle.
The 4% Rule is 50% of the Equation
Many financial planners will point you toward the 4% rule as a guide for how much to withdraw annually from your retirement savings. Based on historical data on returns from 1926-1976, a 4% withdrawal rate is projected to last 33 years in retirement. The key is to adjust the percentage annually for inflation. That sounds simple until we start asking questions like “4% of what?” or “What if I want to retire early, or live longer than 33 years after retirement?”
You’ve probably heard people throw around “magic” retirement numbers, so let’s look at how far 1 million will get you. At 4% withdrawals, you’d have $40,000 annually. Depending on which state you live in and your financial situation, that may or may not provide you with a comfortable lifestyle. But what if you withdraw that 4% during an economic slump? You’ll have to choose between selling more shares at a lower value to get 40k, or you’ll have to make do with less income for the year. Now, what if you have a health emergency? Or what about taking your grandchild on an international trip to celebrate their graduation?
While the 4% rule is a useful guideline, it works best as a rule of thumb, not a golden rule. With that in mind, here are 3 steps you can take to make the 4% rule work as a sustainable withdrawal rate.
Step 1: Plan for Your Retirement
In other words, don’t keep your retirement plans vague. Make time to discuss your ideal retirement with your spouse. Do you want to travel often? Invest in hobbies? Try your hand at an encore career? What about your long-term care plans? Whatever you envision, there’s a cost implication that will affect how much annual income you need. Your dream retirement may mean you need to budget for things like travel insurance, entrance and monthly fees for a CCRC, and more.
There’s no magic number for retirement savings because retirement isn’t one-size-fits-all. Knowing whether or not you’ll have enough starts with figuring out what your dreams involve and calculating how much you’ll need to afford them.
Step 2: Diversify Your Income
You can’t plan for what the market will do, but planning to have additional revenue streams during retirement is a good way to maintain a sustainable withdrawal rate. A passive income source can help you have enough to maintain your lifestyle even during a market downturn. It can also ease some of the challenges of an early retirement.
Let’s say you add bonds or real estate investments to your retirement strategy or save aggressively through an HSA. If you wait until age 70 to start taking Social Security benefits, your monthly benefits will be 132% of what they would have been had you started taking them at age 66. With an additional income source, you can maximize your benefits down the road.
If you retire during a bull market, you’ll need to sell more shares to have enough income, reducing your portfolio’s ability to continue compounding during the early years of retirement. A second career can be a great way to generate additional income. Encore employment allows you to supplement withdrawals while easing the transition to retirement and providing the opportunity to pursue a passion project, work as a consultant, or simply try something new.
Step 3: Adjust Annually
As I like to say, retirement planning isn’t static. With so many variables affecting how much is enough, a cut-and-dried approach to retirement withdrawals just doesn’t cut it.
It’s important to review expenses, inflation, and your portfolio as well as calculate anticipated costs on a regular basis. You’ll want to audit your investments with the help of a financial planner and evaluate whether or not your holdings line up with your strategy. And don’t forget to consider the tax implications! Like all areas of financial planning, calculating withdrawals for retirement works best when you take a holistic approach that keeps your plans in focus.
You don’t have to live with the fear of outliving your savings, and you don’t need to sacrifice your dream retirement because you don’t know how much to save. As a CERTIFIED FINANCIAL PLANNER® whose goal is helping you find what works for you, I would love to help you create a plan that takes the guesswork out of retirement withdrawals. If worry is ruining your retirement plans, give me a call. Let’s get you back in control of your financial life.
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Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Caviness Wealth Management, LLC, a Registered Investment Advisor and separate entity from LPL Financial.
