We all have different ideas on how to live our lives and one of the more popular options is retiring early. How much money you need, though? Let’s take a look at what experts are saying based on your lifestyle.
The “retirement calculator” is a tool that will help you determine how much money you need to save in order to retire. It also includes information on what the average retirement age is and how long it takes for your savings to double.
As Ben Le Fort shows out in this piece, the legendary 4% rule isn’t as untouchable as many people believe.
Prostock-Studio / istockphoto contributed to this image.
The 4 Percent Rule: Definitions and Origins
According to the 4 percent rule, you may comfortably remove 4% of your retirement portfolio in your first year of retirement as your first draw, and then calculate each future year’s draw by multiplying the previous year’s draw by the rate of inflation.
To prepare for your retirement, the inverse, or 25-times rule, states that you must save 25 times your first retirement year’s draw (4 percent of 25 times your desired draw is exactly your desired draw).
The 4 percent rule dates back to a 1990s research by financial planner William Bengen, who discovered that a 50/50 portfolio of stocks and bonds would provide at least a 30-year retirement with at most a 4 percent initial withdrawal, adjusted yearly for inflation, beginning before the Great Depression. A further research found that adopting this technique will not exhaust your retirement assets before 30 years, with a 95 percent chance of not doing so.
The following are significant obstacles that may impact how successfully the 4% rule applies to you.
Piotrekswat/ istockphoto contributed to this image.
The 4% Rule Doesn’t Apply to Early Retirees
Le Fort is accurate in stating that followers of the Financial Independence, Retire Early (FIRE) movement should not expect a 4% first withdrawal since early retirees are likely to live in retirement for much longer than 30 years.
In truth, according to the Social Security Administration’s Actuarial Life Table, an American male’s life expectancy at age 40 is 38.59 years. This is already more than 30 years, and the worst part is that half of those 40-year-old males will live much longer, maybe more than 60!
Things are considerably more difficult for women, since a 40-year-old American woman may expect to live another 42.50 years on average. A woman of 50 years old has a life expectancy of 33.26 years, with half of all 50-year-old women predicted to live longer.
As a result, if you’re a FIRE advocate who wants to retire early, you’ll need to save far more than 25 times what you intend to spend in your first year of retirement.
Image credit: iStock/zimmytws
Affluence Influences Mortality
More recent studies, such as one published on the Financial Planning Association’s website by David M. Planchett, PhD, CFA, CFP, point out that the Social Security Administration’s actuarial tables provide averages for the entire population, whereas those wealthy enough to hire a financial planner, and thus those able to save enough for a 3 percent or 4 percent withdrawal to fund a comfortable retirement, live longer.
Planchett utilized the 2012 Immediate Annuity Mortality Table from the Society of Actuaries. This means that a rich American guy may expect to live longer than the SSA’s projection of 29.69 years, even at 50.
As a result, if you intend to retire early because you are wealthy, you may expect to live longer in retirement than the SSA anticipates. Maybe a lot longer.
DGLimages provided the picture.
Backward-looking, not forward-looking, is the 4 percent rule.
According to Planchett, forward-looking expectations imply that a 3% first withdrawal is more acceptable than a 4% initial withdrawal, given that market returns are predicted to be much lower in the next decades than the average market returns of the preceding 90 years.
He estimates forward-looking returns using Morningstar Investment Management LLC’s 2016 capital market assumptions. Based on historical data, the analysis indicated a 92 percent success chance for a 30-year retirement with a 4 percent initial draw, but only a 53 percent success probability when utilizing forward-looking return predictions. In the forward-looking instance, the first draw would only need to be 3% to reach a 91 percent success chance.
Expect a secure retirement on 25 times your initial-retirement-year draw at best, even for a 30-year retirement. It would be significantly safer to accumulate 33.3 times that draw. The success probability of a 4% initial draw with a 40% equity portfolio for a 40-year retirement is 74 percent, but it drops to only 27 percent when utilizing forward-looking returns.
With these forward-looking returns, a 40-year retirement commencing with a 3% initial draw has a 66 percent chance of succeeding. For an early retiree, a 2.5 percent draw or 40-times-initial-draw accumulation could be a preferable option.
Drazen Zigic / istockphoto contributed to this image.
Dynamic Withdrawals and Partial Guaranteed Income’s Effects
The impact of dynamic withdrawals and having various fractions of retirement funds in guaranteed income is perhaps the most intriguing aspect of Planchett’s study (he calculates the latter by multiplying each dollar by 24.23 as the present value of guaranteed inflation-adjusted income for life, weighted by mortality; then calculating the weight of that amount as a fraction of the total retirement fund including the available portfolio).
If a retiree anticipates $25,000 in yearly inflation-adjusted guaranteed income (for example, from Social Security), the lifetime value of such benefits is projected to be 24.23 times $25,000, or $605,750. If the same retiree had a $1,000,000 portfolio, the guaranteed income would be calculated as 37.7% ($605,750 divided by $1,605,750, the retiree’s entire retirement wealth in this scenario). Non-financial assets such as house equity, which may theoretically be leveraged to generate retirement income, such as via a reverse mortgage, are not included in the research.
According to Planchett’s calculations, your safe starting draw for a 30-year retirement may rise by more than 4% of your retirement fortune as your percentage of retirement wealth accessible in the form of guaranteed income climbs from 5% to 95%. Having just 5% of capital in the form of guaranteed income leads in a safe first draw of at most 2.6 percent for persons who prioritize retirement income stability. If 95 percent of their money was in the form of guaranteed income, the same folks may comfortably pull 6.8% at first.
Because so few of us can bank on a guaranteed-benefit pension these days, if you intend to have a sizable retirement portfolio, your guaranteed Social Security income will likely be less than 50%. With a 50 percent assumption, Planchett’s numbers show that the safe initial draw varies depending on how much of your retirement budget is discretionary versus fixed (e.g., travel is discretionary, while rent or mortgage payments are fixed), ranging from 4.1 percent if all of your expected expenses are fixed to 4.6 percent if they’re all discretionary. This makes sense since having more discretion helps you to reduce your spending more when market returns are poor.
DepositPhotos.com provided the image.
While the 4% (or 25-times) rule has been around for decades and is still regarded a good guideline, it is not without its problems.
If you plan to retire early, and especially if you believe market returns will be far more muted in the coming decades than they have been in the past, you should be more conservative in your retirement planning and expect a safe initial draw of 3% or less for your portfolio to have a high probability of not declining to zero before you die.
If you have a pension or other large source of guaranteed income, you may start with a higher draw rate, perhaps as high as 7%, particularly if the majority of your retirement budget is discretionary.
This also means that if you have minimal guaranteed income, you can consider buying an annuity to boost your guaranteed income portion, allowing you to raise your initial draw percentage by up to a factor of three.
This post was syndicated by MediaFeed.org and first published on Wealthtender.com.
Shapecharge provided this image.
MediaFeed has more.
Tinpixels provided the image.
In the “how much does a married couple need to retire at 60” article, it is stated that a retired couple needs $2.4 million in savings. This number is based on the assumption that both spouses are working until age 60 and will not receive Social Security benefits.
- how much money needed to retire at age 60
- how much money needed to retire at age 65
- how much money do you need to retire at 40
- how much money do i need to retire at 62
- how much do i need to retire at 60 calculator