One of the most common questions I get about retirement is “How long will my money last?” Considering the number one retirement fear for most people is running out of money, that really isn’t a surprise. With that in mind, your money can last as long as you need it to if you plan ahead.
There are several factors that determine how long your money will last. Some you can control. The amount you withdraw each year is one example.
Other factors you can’t control, but you can manage their effects. For example, investment returns. You can’t predict the future, but you can affect how you prepare for it.
Understanding these factors is important so you know what you can do to improve them. That’s really the point of the question right? You don’t just want to know how long your money will last. You want to know what to do to make it last as long as you need it to!
In this article I’ll explain what you can do to protect your savings and what you need to consider to make your money last throughout retirement.
How Long Does it Need to Last?
Running out of money when you still have years left to live is a pretty rough condition to be in and clearly one you want to avoid.
So how long will you last? We obviously can’t know that with absolute precision, so let’s start with some educated anchor points.
Actuaries can estimate average lifespans for a population pretty accurately. Because the U.S. population is so large, statistics provide pretty good insight into life expectancy. We can even break it down by age. That part is important because your life expectancy isn’t constant over time, and your expected remaining lifespan doesn’t decrease at an even rate. You’ll want to think about your own life expectancy relative to your own age.
The Social Security Administration’s Office of the Chief Actuary publishes life expectancy tables that can help us with that. These tables tell you the remaining life expectancy for both males and females at various ages. This gives you a good basis to start from.
I’ve re-post a few key benchmarks from the table. I’ve rounded the life expectancy to the nearest whole year.
|Age||Expected Life Remaining: Male||Expected Life Remaining: Female|
|50||30 years||33 Years|
|60||22 Years||25 Years|
|70||15 Years||16 Years|
|80||8 Years||10 Years|
|90||4 Years||5 Years|
With this information you can figure out an appropriate retirement planning period for yourself. My general default in retirement plans is to bank on living until you are 90. There is some inherent safety in planning to live that long. Take, for instance, a 60 year old retiree. Their average life expectancy is in their early to mid 80’s. If we make a plan to have money until we are 90 then we are padding in a few extra years beyond the average.
It gives us a little bit of a buffer in case things go wrong and we don’t die quick enough!
Adjust this estimate where appropriate. Take an extreme example where not a single person in your family has ever lived beyond 70 because of a common trait like a hereditary heart problem. It would make sense that you may not need your money to last until you are 90.
Most examples aren’t that extreme but you get the idea. If there is good reason to believe that your life expectancy is different from the averages then make some adjustments to your plan.
How Much Money Do You Need Each Year?
One of the most basic things you need for any financial plan is a budget. Retirement is no different. I’m not suggesting that you need to account for every penny, but having at least a broad idea of where your money goes will help you figure out how much you need to support yourself each year. It also helps you see if you might be leaking any money that you could use elsewhere.
I have a simple rule of thumb for figuring out how much you need in the first few years of retirement… About the same as what you needed in the last few years you were working.
I say that because while you reduce some items in your budget, like retirement plan contributions, you will probably increase others, like travel. Remember that you are only one day older the day after you retire!
Again, this is a basic rule of thumb that can you can adjust where you see obvious opportunities. Don’t set yourself up for failure here by carving out a bunch of expenses and assuming you won’t have them after you retire. Clothing is a prime example. Depending on your job you may not need to spend as much on clothing when you retire, but it’s not like you’ll wander around naked all the time. You might make it until noon on the first day before someone calls the cops.
If you fool yourself here, you’ll put your whole plan at risk when you retire and realize you need to withdraw a lot more than you had planned for. If you have to start taking significantly larger withdrawals, your money won’t last as long as you thought it would.
It may help to put your budget into a spreadsheet that you can update easily. You can also create a basic account to use my budgeting app for free here.
Once you get an idea of how long you expect to live and how much you need to spend then you have a target to aim toward. You’ll also need a plan for HOW you are going to withdraw money from your savings to in retirement.
Here’s the setting…
When you retire you need to take a lump sum of money and turn it into spendable cash over that multi-decade retirement period. It may seem like a simple idea, but there are a lot of different ways to do that. Each has it’s own pros and cons.
This rule suggests that you can withdraw 4% of your savings the first year you retire, and increase your withdrawals for inflation every year after. Historically, this rule provided for at least 30 years worth of withdrawals without running out of money. As far as withdrawal rates go, this is the baseline rule of thumb.
There’s some inherent safety built into this rule as well. A 4% withdrawal rate historically provided at least 30 years of withdrawals even in the worst cases. In most 30 year periods you would not have even come close to running out of money. In fact, most account balances actually ended higher than they started!
That’s why Bill Bengen, the author of the 4% rule, named it the safe maximum withdrawal rate.
That doesn’t mean that you can absolutely count on a 4% withdrawal rate to last that long in the future though. We don’t know what investment returns will be going forward.
The other side of that coin is the fact that since most retirees would have ended up with higher balances than they started with, they left money on the table. In a perfect world you’d spend the last dollar of your savings on your last day to live. You may want to balance your desire for safety with your desire live the best retirement you can. The 4% rule leans much closer to safety.
One reality of retirement planning is that we have to plan for uncertainty and the 4% rule is one means of doing that.
How does that help you figure out how long your money will last?
Look at that dollar amount you figured up in your planned retirement budget. Now consider how much that is as a percentage of your savings. For example, if you have $750,000 saved in your retirement account and need to withdraw $75,000 that’s a 10%. You’d need to withdraw 10% of your savings to cover you first year of expenses.
If your percentage is much higher than 4% you’ll need to consider that your savings may not last for 30 years. There is a calculator at the bottom of the 4% rule article that will show you how long retirement savings lasted with different withdrawal rates. 10% is a very high withdrawal rate and your money would likely no last very long.
I particularly like the variable withdrawal rate method. The Guyton-Klinger variable withdrawal method gives you guidelines for adjusting the amount you withdraw from your savings to account for fluctuations in your investment values.
What I like about this rule is that you are able to increase your starting withdrawal rate by making some very reasonable adjustments. The essence of the rule is that you decrease your withdrawal by 10% when your portfolio value drops beyond a certain level, and increase your withdrawal by 10% when your portfolio increases beyond a certain level. By following this system you can better balance that trade-off between safety and leaving money on the table.
A 10% increase or decrease in your withdrawal is noticeable but manageable. You may have to make some budget adjustments if you need to reduce your withdrawal but remember you were able to start with a larger withdrawal by using this strategy.
That’s only one way to incorporate variable withdrawals into your plan, but it’s based on sound research and improves your retirement outcome. If you decide to use a different method just make sure you have the rules established from the beginning and that they make sense. You don’t want to make it up as you go.
No matter what your budget is or how you decide to plan your withdrawals, you have to consider whether your investment plan supports your distribution plan. If these two things don’t jive, your plan stands a good chance of failing.
The key here is to earn enough return to sustain your savings in the face of retirement withdrawals, but not take on too much risk so that your portfolio is ruined if the market takes a nosedive.
The main way you have of balancing protection for your portfolio and earning enough return is through your asset allocation choice. This is the top-level view of your investments. Your asset allocation is the percentage of stocks and bonds that you are invested in. For example, a 70/30 asset allocation is made up of 70% stocks and 30% bonds. This includes mutual funds and ETFs that hold stocks and bonds.
If you have more of your money invested in stocks (or mutual funds that own them) then you will likely earn a higher return than you would with bonds. The downside is stocks are riskier than bonds, so you’ll take a harder hit during bad markets.
So what is the ideal investment mix for a retiree? There isn’t a single best answer, but there is a range of good ones. Most research supports an asset allocation anywhere from 50%-80% of your savings in stocks. If you hold more than 80% or your money in stocks or less than 50%, you are exposing yourself to risks that could mean your money won’t last for your full retirement.
Let’s break that down a little further to see why. You’ve probably heard that you need to reduce the amount of stock you hold as you get older. This is generally true as you approach retirement. When you are younger you can be more aggressive and invest more heavily in stocks to earn a higher return and accumulate a sizable nest egg.
Reducing your exposure to the markets by shifting your investments towards bonds reduces the chance that a major market decline will wipe out your savings as you get closer to retirement. At that point asset protection becomes more important than asset accumulation.
However, the trade-off is that you give up potential return. Ibbotson’s Yearbook publishes data on historical investment returns. Since 1926 the average return on stocks has been about 16% while the average return on bonds has been about 6%. Don’t read too much into those values. Market conditions change all the time and you can’t assume you’ll earn those rates going forward, especially for short intervals. But that’s a lesson for another day.
The point here is to notice the difference in those values. Bonds will likely give you a much lower return than stocks. That’s especially true now. Bonds have very low yields as the Fed cut rates throughout 2019. The reality is that most people will not be able to produce enough income from their savings with just bonds, or even a very large allocation to bonds. Once you account for inflation increases over several years your withdrawal will likely start to overtake your portfolio if you hold too much of your savings in bonds.
That’s where the lower bound of 50% in stocks helps you. You need that extra boost.
Stock Market Risk
So why not more than 80% in stocks? On that end of the asset allocation spectrum you are probably taking on too much risk. If the market tanks like it did in 2007-2008 you would run the risk of depleting your savings. The risk here isn’t in the lack of a long-term average return. The risk here is in the major market declines.
The problem is that you don’t stop withdrawing from your savings during poor markets. You are going to want food and electricity no matter what the stock market does. If your portfolio value plummets because you hold too much stock then that withdrawal takes a much bigger bite out of it.
The correct allocation for you depends heavily on your own feelings toward risk. You need to spend some time thinking through what you are comfortable with, but use that range as benchmark.
You know you need to invest in stocks, but don’t take on more investment risk than you are comfortable with. It will stress you out and you’ll likely end up making changes at the worst possible time. One good way to protect yourself and savings on the downside is with an income floor.
The idea of an income floor is to invest in such a way that you have a fixed minimum amount of income available to you regardless of what happens in the market. It’s an income safety net. The comfort that provides you should allow you to stay calm when the rest of your investments aren’t doing so well. It could keep you from panic-selling and make your savings last longer.
So how do you give yourself an income floor?
An easy way to build an income floor is with a bond ladder. To create a bond ladder you buy bonds that mature in the amount you need each year. Envision the different rungs on a ladder. Each rung represents a year of income. If you want to build an income floor to get you through the first 10 years of retirement, your ladder needs 10 rungs.
This helps because you know you will have a guaranteed amount of savings become available every year. It should give you peace of mind to hold those stocks through bad markets.
Because the main purpose of a bond ladder is to establish a safe minimum, credit quality is very important. Don’t build your bond ladder with low-quality bonds.
How much floor do you need? Go back to that budget. Look at the expenses you have and pick out the ones that you know you would need to cover no matter what. Your floor should be enough cover those.
Understand that an income floor can be “expensive” in the sense that you give up some upside potential by locking in a floor. Remember that bonds usually provide lower returns than stocks over the long term. Any amount of savings you dedicate to an income floor won’t be available to invest in stocks. That’s also the point though. This portion of your retirement savings is protected from market fluctuations.
You might not have thought about the connection between Social Security and making your savings last, but that connection is pretty strong. Social Security retirement benefits provide part of that income floor that isn’t tied to the stock market. Social Security planning that maximizes your benefit can relieve a lot of pressure from your investments.
You’ve probably heard that Social Security is going broke and won’t be around in the next 20 years. There are some problems affecting Social Security, but the situation isn’t as bad as some politicians and salespeople want you to believe. On it’s current path Social Security will support about 70% of promised benefits after 2035 if nothing is done to correct it.
I’m not saying that as taxpayers and voters we should be ok with that. I’m saying 70% is a far cry from nothing and shouldn’t be ignored. If you aren’t actively planning to maximize your benefit you will likely leave a lot of value on the table.
If you have a strong base of income unrelated to your investments, like Social Security, then your money is likely to last longer.
Making sure your money lasts throughout retirement involves managing risks. Rather than thinking of a vague notion of risk though, lets identify a few key risks. Identifying specific risks allows you to address them in targeted ways that can significantly improve how long your money lasts.
Inflation – A Nickel Ain’t Worth a Dime Anymore
Inflation pushes prices up over time, and a dollar buys less and less each year. You can’t individually do anything to stop that, but you can protect yourself from it.
The risk inflation brings to your retirement savings has to do with the amount you withdraw. Because prices tend to rise over time you’ll need to withdraw a little more each year to able to buy the same things.
As an example if you withdraw $50,000 from you savings in the first year of retirement when inflation is 4%, you’ll need to withdraw $52,000 the next year just to keep up. Those larger withdrawals weigh heavier on your savings.
You handle this inflation problem mostly through your asset allocation. Stocks will generally provide an above-inflation return over longer periods. That’s part of the reason it’s important not to hold too many bonds.
There are also inflation-protected investments like Treasury Inflation Protected Securities. These government bonds have interest payments that adjust with inflation.
Some pensions and Social Security also provide protection through cost of living adjustments. The Social Security claiming decision is an important one partly because of the protection it provides from inflation.
Sequence of Return Risk
A more complex retirement risk is the sequence of market returns in the first few years of retirement. If the market goes off a cliff the year you retire, that’s much worse than if it happens ten years into your retirement.
That risk is on a sliding scale. The first few years of market returns have a very large effect on how long your money will last. The earlier the year, the more effect it has. The farther int retirement you are, the less it matters.
Good returns early in retirement has also have a much larger positive effect than good returns later. If the market takes off for the first few years of retirement then you are in good shape. If the market is strong enough in the first few years you may not have to worry about it at all later.
A “simple” way to protect your savings from this risk is to simply avoid it. If the market tanks right as you plan to retire you can delay retirement. I know that’s easier said than done. It’s kind of like a diet. There’s really no mystery to it, it’s just not any fun. If your retirement is already strained though delaying even a year in a bad market could add several years to your savings.
The reason sequence risk is so significant is because you are pulling money out of your retirement accounts. You don’t have the same problem when you are saving over the course of your career.
When your account value falls, your withdrawal takes a bigger bite. Let’s look at a $50,000 withdrawal again. That’s only 5% of a $1 million retirement account. But if your investments plummet to $500,000… that $50,000 withdrawal is now 10%.
Once again, your asset allocation will determine your exposure to this risk. Holding more bonds in your portfolio will reduce the affect of a bad market. You want to hold a more conservative portfolio in the years surrounding retirement to protect your savings from sequence of return risk. Once you get past the first several years you could even start increasing your stock position.
An income floor and a variable withdraw rate also protect you. If you use either of these strategies you won’t have to take such a large withdrawal in bad years. Since the floor covers your necessities you can take a smaller amount from your savings. If you have a floor and use a variable withdrawal rate for the rest of you savings that is even better.
How to Invest in Retirement
We haven’t talked specifically about how to invest in retirement. Asset allocation, income floors, and sequence risk all play a part in how you should invest, but the specific investments you choose matter too.
Diversification is an important component of your investment strategy. If you are too heavily concentrated in any single stock then you run the risk of losing a lot of your retirement savings because of any single event that affects that company. That’s a risk you don’t want to take with something as important as your retirement savings. You reduce that risk by investing in many different companies across a variety of markets.
Index funds are an easy and efficient way to accomplish that. An index fund will buy stock in companies that represent an index like the S&P 500 or international markets. With one mutual fund or ETF purchase your money is divided out among all those different stocks.
Index funds are cost-effective too. The internal expenses of index funds are very low because of their passive investment style.
What About Dividends?
Can I just load up on dividend-paying stocks and live off of the dividends? It would be nice if it were that simple but there are a few reasons you don’t want to do that.
Dividends aren’t certain. Dividends are paid out of corporate earnings, and when those earnings fall the dividend can be cut.
If you concentrate your investments in stocks with high dividends then you are also reducing your diversification. This compounds your risk because if corporate earnings fall market-wide then not only might your dividends be cut but you’ll also wish you weren’t so concentrated in similar stocks.
The higher long-term return on stocks over bonds is fueled partly by dividends. If you aren’t reinvesting dividends, your portfolio won’t grow as much. In that sense, any dollar of dividends that you spend is just like any dollar you spend from your investment principal.
There’s nothing wrong with dividends and they can be an important part of your investments, but it isn’t a good idea to completely rely on them for your retirement income.
Taxes also eat away at your retirement savings and affect how long your money lasts. You need to be conscious of taxes on both your investment balances before you take the money out, as well as your withdrawals.
Be mindful too that tax planning in retirement is viewed over a span of years. It isn’t just about reducing your current tax liability when you file your tax return for the year. You need to think about what lowers your average tax rate across your entire retirement.
If you hold any of your retirement savings outside of tax-advantaged retirement accounts like IRAs, 401ks, or 403bs then you will have to pay taxes on your investment transactions. Here, it is important to be aware of capital gains tax rules and understand what is taxed at income tax rates or capital gain rates.
A penny saved is a penny earned and you can save a lot of pennies managing your taxes. The lower you can get your taxes in retirement the longer your money will last.
Interest and non-qualified dividends are taxed at ordinary income tax rates. Because of that, it is better to hold these investments inside tax-advantaged accounts when possible since distributions from these accounts are taxed as income anyway.
When you buy or sell stocks (or index funds that hold them) you pay taxes according to how long you have held the investment. If you have held the investment for longer than a year your tax bill is based on the lower long-term capital gain tax brackets. Your holding period becomes a very important part of your investment strategy. When possible, hold on to investments for at least a year to push them into long-term capital gain category.
How are Withdrawals Taxed?
Withdrawals from tax-deferred retirement accounts are taxed as income. Distributions from Roth accounts are tax-free. If you have a combination of Roth accounts and tax-deferred accounts the you have a good opportunity for tax planning.
Instead of taking your entire withdrawal from one account, take a portion from each account. This may give you a higher tax bill in the current year, but your average tax rate throughout retirement will be lower.
Remember that income tax rates are progressive. The more taxable income you have, the higher rate you pay.
If you blend your withdrawal from the Roth and traditional account you’ll only be taxed on part of it. This will allow you to stay in a lower tax bracket than if you take the entire distribution from one account. That’s true even if you start with the Roth account. You’ll eventually only have the tax-deferred account left and will be forced to take the entire distribution from there. That will push you into the highest tax bracket for that dollar amount.
How Long Will My Money Last in Retirement?
There’s no magic answer that works in all situations. Use this article as a guide. If you consider all the elements I’ve laid out here and take the time to work through them then your money should last as long as you need it to.