How Long Will My Retirement Money Last?
When creating a financial plan, many investors focus on their retirement “number” – the amount of money they need to save to be able to retire. However, to make sure this number is as accurate as possible, another figure needs to be calculated: the length of time your retirement money will last. Determining this has become more and more important in recent years, for several reasons:
- Social security income is unlikely to completely cover your retirement expenses
- Defined benefit pension plans paying fixed monthly payments upon retirement have become less common
- Advances in health and fitness have led to longer lifespans among retirees
These factors add a degree of uncertainty to the process of figuring out both how long your retirement money is likely to last and how long it needs to last. In terms of how long it needs to last, life expectancy tables can only provide averages for people within an age group – your actual lifespan may diverge widely from such averages. Because of this, when determining how long your retirement income should last, erring on the side of caution is recommended to reduce the likelihood of outliving your income.
A similar dynamic applies when trying to determine how long your retirement savings will last. Projecting investment returns, especially when investments in the stock market are involved, is by no means an exact science. While fixed income investments such as bonds or CDs do offer specified rates of return, these rates are only fixed for the duration of a security’s term to maturity. Rates are likely to change to some degree over time, making it difficult to pin down exactly how much income you will receive from fixed income investments over the course of your retirement.
While these complications should not deter you from attempting to determine how long your retirement money will last, they do add to the complexity involved in doing so. Considerations related to computing your retirement money’s longevity, covering three types of retirement savings vehicles, are described below.
- Annuities and Pensions
If you rely entirely on guaranteed payments from pension plans and social security, along with annuity income from annuities purchased from insurance companies, no calculations are needed: your retirement income will last for your lifetime. While receiving guaranteed retirement income is, by and large, a good thing, having such income make up all or the vast portion of your retirement income does come with certain drawbacks.
One downside of receiving guaranteed income of this type from an annuity provided by an insurance company is that to do so you must often give up access to all or some portion of the principal, which restricts your liquidity in the case of an emergency. In addition, fixed incomes are vulnerable to the impact of inflation, which can result in a loss of purchasing power over time. If some of your retirement money is invested in stocks or bonds, you gain the flexibility to invest in securities which pay higher interest rates or offer the opportunity for higher returns to help you keep pace with a rising cost of living.
- Fixed-Income Portfolios
As we have seen, when fixed-income investments are reinvested at different rates, it complicates the determination of how much income you will receive from your savings during retirement. If your retirement savings will be predominantly invested in bonds, CDs, savings accounts and other such investments, there are several methods for estimating the rate of return they will earn, including:
- Historical returns: This method uses historical returns generated by bonds and other fixed-income investments to project future returns. For instance, if a portfolio of bonds has generated returns averaging 4% per year over the past 30-year periods, this figure could be used for projecting future returns.
- Expected future conditions: This method attempts to predict the effect future economic trends will have on interest rates as a means of projecting future returns from a portfolio of fixed-income investments. For example, if high rates of inflation were expected in the future, and bonds returned 6% on average during such periods in the past, this figure would be used.
- Blending: This method combines the historical and expected future conditions methods to produce an estimate that reflects both past results and expected future economic conditions. For instance, if historical returns averaged 4%, while the expected future conditions method provided an estimate of 6%, the blended approach would provide a rate of 5% if both methods were weighted equally.
Once you arrive at a projected return figure, you can use a retirement savings withdrawal calculator to determine how long a given amount of retirement money will last at a specified rate of return with specific withdrawal amounts. Given the uncertainty associated with any projection of future interest rates, different rates should be used to devise alternate scenarios for the longevity of your retirement savings.
- Blended Stock and Bond Portfolios
As you enter retirement, very few advisors suggest that you invest all your savings in the stock market, given the volatility associated with such investments. However, investing some portion of your retirement money in equity investments, such as stocks or mutual funds or ETFs containing stocks, is often recommended as a means of helping your investment portfolio keep pace with inflation over the course of your retirement.
While the stock market has typically risen over extended periods of time historically, returns have varied widely over different periods of time. Because of this, if a significant portion of your retirement money is invested in equities, using a retirement savings withdrawal calculator to compute how long your retirement money will last can be problematic – doing so could easily produce an inaccurate number. For instance, if the stock market returns 5% over the course of your retirement but you projected it to return 9%, you could run out of money far earlier than expected. One approach to dealing with this issue is to focus on how long your retirement money is likely to last given a certain withdrawal rate each year based on the historical performance of blended investment portfolios.
The 4 Percent Method
The 4% rule is based on research using historical return data showing that the method’s use, for the most part, has provided retirement income lasting at least 30 years. Using the 4%, approximately 50% or somewhat more in stocks and the rest in bonds. You would then withdraw 4% of your savings in the first year, and each year thereafter you would add an adjustment to reflect inflation to the amount withdrawn in the prior year.
In recent years, this method has come in for criticism that it doesn’t accurately reflect current market conditions. This has led some experts to recommend an alternate approach that involves annually adjusted withdrawals from your retirement savings.
Annually Adjusted Withdrawals
Criticism of the 4% method has focused on the claim that, for the bond portion of a portfolio, it reflects past returns generated during periods of much higher interest rates. The same critique about incommensurate past returns could also apply, of course, to stock market investments. If this criticism is true, and future interest rates or returns on equity investments fall below historical ones, and you continue taking a 4% or greater withdrawal every year regardless of your portfolio’s actual performance, you risk outliving your retirement income.
An alternate approach that avoids this danger is to adjust your withdrawal amount each year to reflect your portfolio’s performance in the previous year and your life expectancy going forward. Using this method, which can also be utilized on portfolios entirely made up of fixed-income investments, you can extend the time your retirement income will last. The Society of Actuaries provides this life expectancy calculator that can help you recalculate your withdrawal amount each year.
Using this approach offers only an approximation of how long your retirement money will last, using the 4% rule as a starting point. The flexibility it offers, however, allows you to more closely align your retirement income with your lifespan than would be the case with strict adherence to the 4% rule.