Today, we help you understand how to make your money outlive you.
The topic of “outliving your money” arises often.
To help ensure your money outlives you, understand these three concepts:
#1—Understand the 4% Withdrawal Rule
#2—Include Retirement “Smile” Spending Changes
#3—Apply Sophisticated Financial Modeling Guardrails
Let’s look at each step in detail and dispel a popular retirement money myth.
Step #1—Understand the 4% Withdrawal Rule
The 4% retirement income withdrawal rule has been used for decades by many investors and financial advisors.
It’s a general rule-of-thumb to help ensure you don’t overspend and, therefore, run out of money during retirement.
Specifically, 4% is considered a sustainable annual withdrawal rate that maintains your savings throughout retirement.
It’s a helpful benchmark.
However, it often doesn’t include all income forms (e.g., apartment rental, Social Security, pension, etc.), or life events (e.g., divorce and helping adult children financially).
4% Rule in Action: Married Couple Example
The below chart depicts a married couple beginning retirement with $2 million in savings, and after applying the 4% rule, having roughly $2.6 million in savings 30 years later.1
That’s right, they end up with more money than they started with.
This example accounts annually for: 2.5% inflation, 6% portfolio growth and 4% income withdrawal, with the couple starting retirement on January 1 and withdrawing $80,000 for the year.
Generally speaking, when you use the annual 4% sustainable withdrawal rate, you likely won’t run out of money in retirement.
Deep Dive: See Fidelity’s comprehensive explanation of the 4% withdrawal rule.
Step #2—Include the Retirement “Smile” Spending Changes
In reality, most retirees spend similar to the retirement smile.
Specifically, spending is higher in initial retirement years, dips during middle years and then increases again in later years.
Simple Example:
Many retirees spend extra on travel during early retirement. Then as you age travel drops off, while health care spending grows.
Up, down, up = smile.
Image created using Microsoft’s AI image creator.
Continuing the 4% rule example above, the couple would withdraw at least $80,000 from savings each year to cover their expenses.
However, this number isn’t always reflective of reality.
Some years the couple’s withdrawal rate may need to be higher, perhaps $120,000.
Why?
Because hot water heaters break, pool liners tear, vehicles become unreliable and adult children sometimes ask for loans.
We can budget (links to/downloads our budgeting worksheet) till we’re blue in the face and we should! But, life happens.
Therefore, to help make your retirement savings last, consider how spending changes throughout retirement.
Step #3—Apply Sophisticated Financial Modeling Guardrails
There’s a popular myth about retirement.
Specifically, many retirees believe stock market performance could cause them to run out of money.
This isn’t likely true.
Instead, your greatest financial risk is generally longevity risk.
Stock market risk can be greatly reduced by how your portfolio is constructed.
For Example:
The market generally falls about 14% in a given year and bounces back, and one out of five years it typically drops up to 30% for a period.
We help protect you from these fluctuations during retirement by putting about two-to-three years of money aside (cash-like investments still earning interest), so you’re not selling during a down market to fund living expenses.
Managing longevity risk, however, requires sophisticated financial modeling to help reduce the possibility of running out of money in retirement.
Our team uses several financial modeling programs to help you understand what you can spend each year during retirement without running out of money.
One key feature is the ability to apply “guardrails” that show how your money performs during both up and down years.
Ultimately, we stress test your money by applying different scenarios, e.g., retiring during the 2007 financial crisis.
The goal is to keep your spending within the guardrails. Ultimately, your annual “paycheck” may fluctuate some year to year.
Here’s one program in action, using the couple’s $2 million:
The following graph depicts upper (green) and lower (red) guardrails with the couple’s portfolio balance in blue.
Each vertical line shows an intersection whereby the couple can withdraw more than their annual $80,000.
How are the guardrails set?
Our goal is to keep you from hitting the red guardrail.
Therefore, when establishing your unique guardrails we consider your age, goals, health, risk tolerance and how much money you have, while also putting aside a couple years of spending so we don’t have to invade the portfolio during market down years.
In general, we construct your portfolio to stay in between the market’s highs and lows.
We also use historical data to drive the highs and lows. (It goes without saying we don’t know what the future holds.)
As you can see, there’s a lot going on here, including establishing guardrails and spending limits based on unknown longevity.
Reach out anytime to discuss. We’re happy to show you various retirement withdrawal scenarios using your unique guardrails.
Before You Go
Get help optimizing your retirement income. Download our FREE “Prolonging Retirement Income” checklist.
Also, receive help retiring to the life you want, schedule a complimentary financial planning consultation.