Managing Expenses After Retirement
Once you enter retirement, a key decision is determining how much money you can take out of your retirement accounts to pay for your living expenses. You clearly need enough to make ends meet (along with other sources of income such as Social Security, a pension or annuities), but you don’t want to take out too much so fast that you run out of money later on.
Withdrawal rates are critical if you don’t want to outlive your money. Generally you should plan to have your money last at least 20 to 30 years in retirement. Many people are living longer than previous generations, so count on many years to come.
Managing Your Retirement Withdrawals
One way to help prevent withdrawing too much is to take out no more than 4 percent of your accumulated retirement savings in your first year of retirement, and then multiply that number by 1.03 every following year. That 1.03 factor is basically an inflation adjustment of 3 percent each year, so you can maintain your standard of living in retirement. You can adjust the inflation factor up or down each year depending on the economy and inflation rates. For example:
- You have $500,000 in your retirement accounts. The guideline withdrawal rate of 4 percent of that amount means a $20,000 withdrawal for your first year of retirement. For your second year, multiply $20,000 times the inflation factor of 1.03 to get a withdrawal of $20,600. For your third year, $20,600 times 1.03 equals a withdrawal of $21,218. And so on.
Always remember to be flexible with these withdrawal guidelines. Depending on current economic conditions, you may want to start your initial withdrawal rate at a different percentage, such as 3 percent of your account balance, when times are tough. If your retirement money falls in value in a particular year due to poor returns, it may be very wise to cut back on how much you withdraw for a year or two and/or seek additional income. When your investments perform well again, you may be able to increase your withdrawal rate to a more normal level.
A key factor is the composition of your investment portfolio. The 4 percent rule assumes that retirees invest at least half of their assets in stocks or stock mutual funds. Conservative investors may need to withdraw only 2.5 to 3 percent of their savings balance annually to have a good chance of having it last 30 years.
Be aware that many individuals have unrealistic expectations about how much they are going to be able to withdraw from their savings during retirement. It is important to have good discipline during the first years of retirement, particularly to start off on the right foot and not raid your nest egg too quickly. Also be aware that on the flip side, there may be a psychological challenge of taking money our of retirement savings account after decades of saving. Just as you assess whether you are spending too quickly, also consider if you are spending too slowly.