How Long Will My Money Last in Retirement?
Everyone dreams of their retirement. You’ve probably had a “dream retirement” scenario in your mind for a long time. Maybe you want to travel or pursue a life-long passion. Whatever your goal, you’ve likely been saving towards it for most of your adult life. But imagine getting to retirement and realizing the money you’ve saved won’t last long enough or isn’t enough to allow you to do the things that you planned to do in retirement.
This scenario is probably the biggest single concern of retirees: running out of money. It doesn’t seem to matter how much money they have; the thought of not generating any outside income and living for many years off of an existing pool of assets and Social Security strikes fear in the hearts of many Americans.
That’s where a financial advisor can help. Making your money work harder in retirement is one of their primary jobs. They spend many hours studying and learning about how best to accomplish this goal and stay abreast the many tools and techniques that have been developed over the years to better understand this issue.
Some of these tools are nothing but sales pitches in disguise. Others are so complicated that many planners don’t even understand them fully (i.e. “Monte Carlo simulations”).
Effective retirement planning is not a “set-it-and-forget-it” discipline either. A financial plan for someone who is in the distribution phase of their lives is one that calls for continuous monitoring and adjustment, as well as attention to the markets, economy and political environment.
Still, all good plans to make your money last longer in retirement rely on a few key variables:
1. Getting the spending part right.
In a nutshell, how much will you be shelling out each year, both for normal and recurring items and for extraordinary or one-time expenses? Perhaps your retirement plan calls for an annual expense of $15,000 for travel, as you like to visit your children a few times every year and also take one or two personal trips. Then, maybe every three to five years, you plan on a larger expenditure of $25,000 to spend three weeks in Europe.
Annual car expenses, including funds for an unexpected emergency, also must be factored in. You may have a normal expenditure of $5,000 in fuel and maintenance costs and a periodic expense of $30,000 every 10 years to replace a car, for example. Expenses like these often get overlooked in favor of bigger retirement goals like travel; but, they are just as important, as they allow you to continue your daily routine and lifestyle.
When calculating the lifespan of your portfolio, look at the net or after-tax withdrawals from your accounts after other sources of income, such as Social Security and pensions, are used.
You’ll also need to account for unexpected expenses, such as a long-term health event for you or a spouse. If you haven’t planned for situations like these, it can derail your retirement and quickly drain your accounts. This video can help you see if your retirement savings are protected from these types of events.
2. Understanding the total value of your liquid assets.
Liquid just means assets you can quickly cash in, such as cash, certificates of deposit, money market accounts, stocks, bonds, mutual funds, etc. To make sure your money lasts in retirement, you’ll need to check in on these assets regularly to help you keep track of where you are financially.
3. Correctly estimating the expected growth rate of your investments.
This is after taxes, inflation and investment management expenses. Two of these three variables are within your control – taxes and investment management costs. Tax management can take on a large role in retirement, as asset sales can be timed and gains and losses can be netted against one another, distributions can be timed from taxable versus non-taxable accounts, etc.
Investment management fees should be evaluated and minimized where possible. This includes fees at the mutual fund level and at the adviser level.
As an example, consider a balanced portfolio of 60 percent stocks and 40 percent fixed income and cash. The blended return on this portfolio will probably be in the 7 percent range. For the purposes of this calculation, let’s say inflation the inflation rate is 1.1 percent (but with health care costs being a large factor for retirees, we’re going to use 3 percent). A typical investor will pay somewhere in the range of 1.5 percent for investment management, so our net growth rate is around 2.5 percent.
Taxes may bring that down closer to 2 percent. This detail should impress upon you the impact of the various factors on your portfolio, and emphasize that it truly can be the small things that make a difference.
Ok, so now what? You know the portfolio value, the spending plan and the expected growth rate. How do you find out how long the portfolio will last?
Moshe Milevsky, Associate Professor of Finance at York University in Toronto developed the following simple formula (simple if you have a financial calculator or use a spreadsheet program):
Source: Moshe Milevsky, Financial Analyst Journal, March/April 2016
What this says is that the EL, or expected longevity of your portfolio is equal to 1 divided by the expected growth rate times the natural logarithm of the formula in parenthesis. “w” is your withdrawal amount in dollars, “M” your initial portfolio value and “g” is your expected growth rate.
To get an idea of what the output looks like for a $1,000,000 portfolio, Mr. Milevsky provides the following excerpt:
Source: Moshe Milevsky, Financial Analyst Journal, March/April 2016
You can quickly see the relationship between net growth rate and withdrawal rate. To go back to our earlier example, let’s say you have a $1,000,000 portfolio and expect a 7 percent growth rate, which after inflation, fees, taxes, etc. is a net 2.5 percent rate of return. You could take as much as $60,000 a year out if you are a 65-year-old male and be reasonably certain that it will last for your lifetime (estimated mortality for a 65-year-old male is about 18 years and 20 years for a female of the same age). There are more factors that should be considered, of course, such as the age of your beneficiaries (spouse, children, etc.), life insurance owned, etc., and that’s why a complete financial plan is invaluable to make sure no stone is unturned when making such important decisions.
The bottom line is that these simple ideas can at least get you started thinking, and maybe give you a little guidance in conversations with your financial advisor. And remember, sometimes small adjustments can have a big impact. Kind of like tools in the world of financial planning – sometimes the simpler tools and concepts are the most effective.
Put Some Tools to Work on Your Own
Just as your financial advisor will use tools to help you make sure your money lasts in retirement, you can do the same. If you’re struggling with the calculation above, or if you would just like a simple retirement calculator, these tools may help you. If you are currently retired, see how long your savings could last; or if you are planning to retire soon, learn how long your money may last in retirement.
Once you’ve done a good job of making sure your money lasts, you’ll be able to enjoy the retirement you’ve always dreamed of. Then, you’ll need to make sure you have plans for your legacy and begin to think about who’s going to receive your assets.
By Doug Kinsey, Copyright 2016 Kiplinger Washington Editors