How to Calculate Your Retirement Percentage
Each Monday, we address one of your pressing personal finance questions by seeking advice from several financial experts. If you have a general question or money issue, or just want to talk about something PeFi-related, leave it in the comments or email me at [email protected].
This week a question from waterdragon :
It might skew (well, much) the older one than your average reader might be interested in, but I see very few articles on strategies for retirement and how to counter overspending in the early years.
This is what individual experts usually say about a problem that affects each person differently: if you need personalized advice, you should see a financial planner.
Strive for a low withdrawal rate
There are as many retirement strategies as there are people planning to retire. Without knowing your specific circumstances, but assuming you are approaching retirement age, Drew Parker, financial planner and creator of The Complete Retirement Planner , says that the first step to figuring out your strategy is to create a detailed list of all of your current monthly expenses. This includes essentials like a mortgage or rent and cell phone bill, as well as valuations for things like meals and gifts for your grandchildren. This will give you a baseline amount of how much you are likely to spend each month.
“Seeing where your money is going in black and white opens your eyes and helps you prioritize,” says Parker. As a final step, before retirement, you should aim to overspend by no more than 5-10 percent of what you indicated in the following months. “This goal acts as a reminder to help you avoid wasting money without thinking about the consequences. If you consistently spend more than you planned, your withdrawals should be higher, and you risk running out of money in a very vulnerable place in your life. “
He then proposes a “needs-based approach” for withdrawing funds. In this scenario, the amount you will need to withdraw each year will equal your total annual expenses (which you can roughly calculate from your breakdown) minus your annual net income (after taxes, including social security). Later,
Divide this total withdrawal amount by your total savings. In theory, if the percentage received is less than five percent, you should be fine. If it’s five to 10 percent or more, especially in the early years of retirement, it probably won’t be sustainable unless your spending drops significantly over time.
You can try it on your own, or, ideally, go to a retirement professional to help you with the math.
“You want to plan your expenses, income and withdrawals by year so you can see at a glance what happens if you make changes to any of them in any year,” says Parker. “You have to plan to have enough money for at least 90 years.”
Here’s an example, provided by Parker, of $ 1 million in savings at age 65, a return on investment of four percent (rather conservatively), $ 45,000 a year in net spending, and a 2.25 percent inflation rate on that spending.
“This is a very simplified example, but it proves that withdrawal rates can grow steadily over 25 years without running out of savings,” he says.
Follow the four percent rule
Michael Brodsky, financial advisor for Ameriprise, says he advises clients to follow the “four percent rule,” a fairly simple withdrawal strategy that you can change up or down depending on your specific goals.
“If the portfolio is well diversified, then the rate of return will hopefully rise slightly over time, even after spending that four percent annually,” Brodsky says. “Having a diversified set of many different investments gives you some flexibility in deciding what to sell at any given time, and can help prevent pressure to sell a particular investment at a time when its value falls.”
All this, of course, will depend not only on your expenses. Your age, marital status, and other sources of income (social security listed above or a defined benefit plan) are also important factors. For example, if you retire later, you could theoretically withdraw larger amounts.
Here’s some additional information on when to withdraw money from where:
You can read about some of the other options (and the rules for withdrawing funds from your various accounts) here .
Protect your principal
Most importantly, you want to protect your principal. Rebecca Walser, a tax attorney and certified financial planner, says as you approach retirement age, you can’t rely on social security and a retirement account alone – you need to have money somewhere else to protect your principal. You don’t want to be caught with all your (nesting) eggs in one basket, as was the case with many retirees in 2008-2009.
“We need to think about whether we should start protecting our portfolio from losses,” says Walser, whose book, Unbreakable Wealth: Growing Wealth Uninterrupted by Market Crashes, Taxes, or Even Death , came out last month. “Many people turn it into a long-term CDs, indexed on the market CDs or annuities , based on growth “, which protect your base amount , but have the potential for profit.
“There is nothing worse than taking allocations from a portfolio that has just lost most of its value,” she says.
And if you know in advance that in retirement you will have a big trip or expenses, create a separate savings account for this, – Brodsky suggests, – instead of removing it from your principal. “This will allow you to save money to achieve your goal without ruining your [retirement] budget.”
More on this idea here:
It can also be used as extra protection if you spend a little more money in the early years.
A larger step, requiring much more planning and thought, is moving into a state with or without lower income taxes . You might not even want to consider this drastic change, but it is an option. You can use this calculator to estimate potential savings.
With regard to young people, Walser emphasizes the IRA of Roth and Roth 401 (k) s. Pay your income tax now and it’s not a problem when you retire (unless you withdraw your money sooner). If you are unable to use Roth in your job, “do your part for [the employer’s] cause and then go somewhere else,” she says. And check yourself for retirement regularly.