A recent Willis Towers Watson survey of more than 5,000 American workers found that nearly a third doubted they would have sufficient resources to carry them through 15 years of retirement and fully half didn’t believe their resources would support them for 25 years. Which is a shame, since with today’s long lifespans many people could very be looking at a post-career life of 30 years or longer. So how can you increase the chances that you won’t run through your savings before you run out of time? Here are three suggestions.
1. Do a retirement budget. Unless you have a good idea of the expenses you’ll face in retirement, it’s hard to really know how much you’re likely to spend and thus how long your nest egg might last. So your first step as you near or enter retirement should be create a retirement budget.
By budget, I don’t mean simply falling back on the rule of thumb that you’ll spend 70% or 80% or so of what you did prior to retiring. That can be a dangerous assumption as recent research on household spending from the Employee Benefit Research Institute shows that many people actually increase their spending early in retirement. Rather, I recommend you do an actual line-by-line budget that allows you to estimate as best you can how much you’ll spend in various categories and then allows you to total your expected annual spending overall.
There are a number of online budget worksheets that can help you with this exercise. For example, BlackRock’s Retirement Expense Worksheet has spaces for some four dozen expense items in eight categories ranging from household and living costs to medical and family care expenses. The worksheet also allows you to tally essential expenses (mortgage, utilities, etc.) and discretionary ones (entertainment, travel, charitable donations) separately, which gives you a better sense of how much room you’ll have for cutting back on spending should that be necessary. Fidelity’s Retirement Income Planner tool contains a similarly detailed budget worksheet that allows you to tag expenses you consider essential. Whichever tool or calculator you use, you’ll be able to get a more accurate fix on your retirement expenses if you do some “lifestyle planning” while you’re working on your budget.
2. Start with sensible withdrawal rate, and stay flexible. There’s no official standard for what constitutes a sensible withdrawal rate. But if you want to have a reasonable shot of your savings supporting you through a retirement of 30 or more years, you should probably limit yourself to an initial withdrawal of roughly 3% to 4%, and then adjust the resulting dollar amount by the inflation rate each year to maintain your purchasing power. You can start with a higher rate if you feel you need more retirement income. Just remember that higher withdraw rates carry a greater risk of exhausting your savings too soon.
Whatever rate you decide to start with, you should stand ready to adjust it periodically. For example, if the stock market tanks or delivers a string of anemic returns, especially early in retirement, the combination losses or low principal growth and withdrawals could so deplete your nest egg’s value that you might run out of dough sooner than anticipated. In such a case, you’ll probably want to scale back withdrawals for at least a couple of year to allow your nest egg to recover.
Conversely, if your investments perform well, the value of your retirement accounts could swell, in which case you might want to boost withdrawals and indulge yourself a bit, rather than end up with a large nest egg in your dotage when you might not be able to enjoy it as much. By going to a retirement income calculator that uses Monte Carlo simulations to estimate how long your money might last and plugging in such information as your nest egg’s current balance and your current rate of spending, you should be able to adjust your withdrawals to balance the risk of spending too much against the risk of spending too little.
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3. Consider buying guaranteed income for life. One way to ensure that your nest egg will generate at least some income in addition to Social Security for the rest of your life regardless of how the financial markets perform is to devote a portion of your savings to an annuity. Annuities come in a wide array of types with a bewildering variety of features. But if lifetime retirement income is your goal, I think your two best choices are an immediate annuity or a longevity annuity.
The premise behind an immediate annuity is simple: You hand over a lump sum to an insurer and in return get a monthly payment for as long as you live. The size of that payment depends, among other things, on your age and the level of interest rates. So, for example, a 65-year-old man who invests $100,000 in an immediate annuity today might receive a payment of $555 a month guaranteed for life. A longevity annuity, on the other hand, is designed to provide income in the future. So while you invest your money now, you don’t begin collecting payments until some point down the road. For example, a 65-year-old who invests $30,000 in a longevity annuity today but postpones payments to age 85 would receive $1,340 a month for life starting in 20 years. (For estimates of the payment you might receive for different ages or investment amounts, check out this annuity payment calculator.)
Of course, if the income you receive from Social Security and pensions is enough to cover all or most of your essential living expenses, you may not need an annuity at all. You should also know that, however appealing their guaranteed income and other advantages may be, annuities also have significant downsides. You typically lose access to the money once you’ve invested it, which means it’s no longer available for emergencies and such, and if you die soon after investing you could end up with very little income, or even none in the case of a longevity annuity. So before you put any money into one, I suggest you check out this column that outlines five tips for finding the right annuity and this one on the three questions you must ask before buying an annuity.
Walter Updegrave is the editor of RealDealRetirement. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at [email protected] You can tweet Walter at @RealDealRetire.