NEW YORK — I’m retired and would like to find out how long my retirement savings will last. Can you help me come up with the answer?–Ted
Sure, but I’m going to suggest you go at this issue a slightly different way. Instead of asking how long your savings will last, which suggests that you want to know how long it will be before your money runs out if you continue spending as you are, I suggest you ask how long you should plan for your nest egg to last so it can support you throughout retirement. Once you decide that, you can then estimate how much you can spend from your savings each year without incurring too big a risk of outliving your nest egg.
Of course, no one can predict how long you’ll live. But I can tell you that given today’s long life spans, it’s prudent to plan as if you’re going to be around quite a while. Otherwise, if you base your spending on the assumption you’ll live a short life and end up living longer, those extra years you didn’t think you’d be around for may not be so enjoyable.
People can quibble about how many years retirees should plan for their savings to support them. But I’d say the consensus is that to reduce the risk of depleting your assets too soon, you should plan as if you’ll live at least into your early 90s, and couples should plan as if one of them will be around even longer. I suggest age 95 as a reasonable starting point for planning purposes. If you have a compelling reason to believe you’ll die sooner, you can adjust that figure downward (although I’d do so with caution) and if longevity runs in your family, you might tack on a few more years just to be safe.
You don’t say how old you are, how much you’re spending, how large your nest egg is or how you have it invested. But just so we can run through an example, let’s assume you’re 65 and have $500,000 in retirement savings, 50% of which is in stocks and 50% in bonds. Let’s also assume that this year you’ll spend 4%, or $20,000, of your nest egg, that you’ll increase your spending by the inflation rate each year to maintain purchasing power and that you want your savings to last at least 30 years, or in this example until age 95.
If you plug that information into the T. Rowe Price retirement income calculator — a tool that uses “Monte Carlo” simulations to forecast the probability that a given level of spending can be sustained — you’ll see that the calculator estimates there’s an 80% chance that you’ll be able to maintain the spending regimen described above for 30 years. Or, to put it another way, if you withdraw 4%, or $20,000, from your nest egg this year and increase that amount by inflation each year, there’s about a 20% chance you’ll run through your savings before you reach age 95.
There’s no official consensus about what is considered an “acceptable” level of assurance. But I’d think that most retirees would want to have at least an 80% or so chance of their savings being able to support them for life.
Now let’s see what happens if you spend more. If you increase that initial withdrawal from your nest egg from 4%, or $20,000, to 5%, or $25,000, and adjust it annually for inflation, the success rate for a 30-year retirement drops to just over 50%, essentially a coin toss. If, on the other hand, you spend less and drop that initial withdrawal rate to 3.5%, or $17,500, the chances of your savings supporting you for 30 years rise to roughly 90%, giving you a higher level of assurance you won’t outlive your savings.
If you feel you don’t need your savings to last 30 years — someone who retires at 70, for example, might want to assume another 25 years of spending — then the chances of being able to sustain a given level of spending would rise. For example, a 70-year-old who withdraws 4% initially and increases that amount annually for inflation might have roughly a 90% chance of his or her nest egg lasting 25 years or to age 95.
Or, you could look at it a different way. If you have a 25-year-planning horizon, how much could you spend if you were comfortable with an 80% chance that your money would not run out before age 95? In this case, the answer would be just over $22,500 a year, or an initial withdraw of about 4.5%. And, of course, the opposite would be true if you were, say, an early retiree who needed his nest egg to last 35 years. You would have to accept a lower level of assurance for a given level of spending or you would have to rein in spending to maintain the same probability of your money lasting longer. You get the idea.
In any case, if you go to the T. Rowe calculator, you can try different scenarios with various withdrawal rates, different numbers of years in retirement and even different stocks-bonds allocations to come up with a level of spending that you feel makes sense (although asset allocation doesn’t have much of an effect on how long your savings will last unless you go to very conservative asset mixes or you move to relatively high withdrawal rates, say, 5% or higher). You can also factor in Social Security, pensions and other income (such as from a part-time job) to get a more comprehensive look at your retirement spending prospects.
As you go through this sort of analysis, remember that estimates like the ones I’ve outlined above are just that — estimates, not guarantees. Your chances of being able to maintain a given level of spending can change, sometimes dramatically, depending on such difficult-to-predict factors such as how the financial markets behave and whether inflation, subdued of late, begins to heat up again. Which is why you can’t just set a spending course and then forget about it. Every year or so you should re-assess your situation with updated information about your savings balances, spending plans (and perhaps even how many years of retirement you think you’ll have left) and then adjust your withdrawals if necessary.
If a severe market downturn has put a big dent in your retirement portfolio, you may need to trim spending a bit. Conversely, if a strong stock market has significantly boosted the value of your nest egg, you may want to spend a bit more freely, so as not to end up with a hefty account balance late in life but regretting that you hadn’t lived larger earlier in retirement when you might have enjoyed it more.
Given the number of uncertainties involved in trying to estimate a sustainable level of retirement spending — how the markets will perform, how long you’ll live, what your actual expenses will be — you might also consider turning a portion of your nest egg into income assured to last no matter how long you live and regardless of how the markets fare by investing in an immediate annuity or longevity annuity. Despite their many advantages, however, these types of annuities also have downsides, the biggest of which is that in return for a guaranteed payment you lose access to the money you’ve invested. So even if the idea of income you can’t outlive appeals to you, you need to carefully consider the cons as well as the pros of an annuity before committing to one.
Bottom line: Until someone can accurately predict how long you’ll live and how your retirement investments will perform, it will be impossible to know precisely how much you can spend from savings each year without the possibility of depleting your savings too soon or ending up with a large nest egg late in life. But if you go through the exercise outlined above and stand ready to tweak your savings withdrawals up or down as you go along, you should be able to strike a balance between the income you need and the security you seek.