Tapping Your Retirement Nest Egg
How much can you annually withdraw from your retirement savings with the least risk of running out of money?
There's no easy answer to this question, especially since you may be depending on your money for some 20 years to 40 years. Plus, it's hard to plan when there's no way to know what investment returns or the cost of living will be in the future.
The exact amount you can withdraw depends on many factors specific to your situation. However, studies published over the past few years in the Journal of Financial Planning offer some guidance.
What the studies say
In general, studies report that if you want to be fairly confident your savings will last for the rest of your life, through both good and bad economic times, you should limit your annual withdrawal rate to a conservative amount.
The studies generally suggest two alternate withdrawal methods.
One method is to initially withdraw about 4% from a diversified portfolio and then annually increase that amount to keep pace with inflation.
For example, if you have $500,000 in retirement savings and you set your initial withdrawal rate at 4%, you would take out $20,000 the first year. Then the next year, if inflation is running at 3%, you'd take out $20,600 (3% of $20,000 = $600).
A 4% initial withdrawal rate may seem like a limited amount. But keep in mind, you have to start with a low rate so you can increase your withdrawals each year for inflation. If you don't increase your withdrawals for the cost of living, you may not be able to cover your future expenses.
A second method is to withdraw a fixed 5% each year with a ceiling and floor on the amount you withdraw. The actual amount will depend on your investment returns.
If you have savings in tax-deferred accounts, your withdrawals are subject to income taxes.
For example, if you have $500,000 in savings and you withdraw 5%, you can initially withdraw $25,000. If your portfolio falls to $400,000 you can only withdraw $20,000, but if it increases to $600,000, you can withdraw $30,000--assuming these amounts are within the ceiling and floor limits you set.
By always withdrawing a fixed percentage from your remaining savings, you're forced to adjust your spending along with your portfolio's performance and you're less likely to run out of money. And by putting a ceiling and floor on the amount you can withdraw, you'll limit the amount you have to cut back in down times.
Your actual withdrawal rate
The amount you actually can withdraw from your savings depends on your other sources of income, how much money you have and how it's invested, and your life expectancy. It also depends on how much you want to leave to your heirs, how much life insurance you have, and whether the majority of your money is in taxable accounts or retirement plans.
Additional factors include how you'd cover possible uninsured medical and long-term care expenses, how willing and able you are to reduce your withdrawals if your investment returns are poor, and how large a cash cushion you have to fall back on.
For example, if a significant portion of your income comes from pension and Social Security retirement benefits, you're less dependent on your savings. Similarly, if you have significant assets, your wealth may allow you to spend more freely.
On the other hand, if you're relying on savings as your major means of support, you have to be more cautious. And if your nest egg is modest, that's all the more reason to rein in your spending.
Overall, your challenge is figuring out how to make your money last without needlessly restricting your lifestyle.
Furthermore, if you have savings in tax-deferred accounts, such as a traditional IRA or 401(k) plan, your withdrawals are subject to income taxes. You'll have to withdraw a larger amount to meet your expenses after paying taxes than if you were withdrawing from taxable accounts.
Overall, your challenge is figuring out how to make your money last without needlessly restricting your lifestyle.
Improving the odds
In addition to sticking with a modest withdrawal rate, one way to make sure you have money coming in is to turn part of your savings into a guaranteed stream of income. You can do this by annuitizing a deferred annuity you already own--by converting it to regular payouts--or by buying a payout annuity with part of your savings.
An annuity can guarantee income to last for the rest of your life, or for both your life and the life of your joint annuitant.
The bottom line
Most important, regardless of how much you withdraw, whether your money lasts depends on your investment returns and how much your expenses increase. If your investment returns are worse than projected or your expenses increase faster than planned, you could run out of money earlier than expected.
That's why it's up to you to reduce the amount you withdraw if necessary. Alternatively, if you're well into retirement and your portfolio has done well, you may want to consider modestly increasing the amount you withdraw.
Whether your money lasts depends on your investment returns and how much your expenses increase.
Retirement income calculators--available through financial advisers, on the Internet, or in money management software packages--can help you crunch the numbers.
Bobbie Shocket Lazarz, Certified Financial Planner Professional TM, MSW, MBA, is the primary author of the CUNA Mutual Group's Education Center Web site. Lazarz has been educating credit union members about personal finance for 15 years. The CUNA Mutual Group is the leading provider of financial services to credit unions and their members nationwide.
October 11, 2004
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