How much can you safely spend each year from your retirement savings without worrying about running out of money? Do you really have enough money saved for retirement? These are critical questions for older workers and retirees to answer, particularly those who don't have substantial pension benefits and are relying on Social Security, 401(k) balances and IRAs for retirement income.
There's evidence that many people are struggling with these questions. For example, a recent survey showed that more than half of all respondents were too optimistic about a safe withdrawal rate. Almost one-third of were wildly overoptimistic and would spend their savings at a rate that would ensure they would almost surely deplete it during their lifetime.
The Society of Actuaries recently published a series of essays that address common retirement risks. The lead essay, written by Evan Inglis, senior vice president in the Institutional Solutions group at Nuveen Asset Management, provides easy-to-understand guidance on the above questions.
"My friends, my parents and new people that I meet all seem to be interested in whether they have enough money saved up," said Inglis. "Even though there are lots of things to think about, for the vast majority of people, very simple guidelines will be most useful."
Inglis starts by describing one straightforward spending rule: Spend no more than 3 percent of your savings each year. For example, if you have $100,000 in savings, you could spend $3,000 in the coming year to supplement Social Security and any pension income you may be receiving.
Each year, you'd recalculate your spending amount to reflect the current value of your savings. This rule assumes you have 40 percent to 70 percent of your portfolio invested in equities, with the rest in fixed-income investments.
This spending rule aims to help you withstand periods of poor stock market returns and provide income in case you live a long time. It isn't intended to enable the highest level of spending. While researching this critical topic, one thing Inglis discovered was that older retirees could safely spend more than 3 percent of their savings.
This realization inspired him to develop the "feel free" spending rule:
- Divide your age by 20 to determine the percentage of savings each year that you can safely spend. If you're married, use the age of the younger spouse.
For example, if you're 70 years old, divide 70 by 20 to determine the "feel free" withdrawal rate that you can safely spend in a year: 3.5 percent. Calculations using age 80 result in an answer of 4 percent.
The "feel free" spending rate is intended to withstand poor investment returns over the period of your retirement. If you achieve favorable investment returns over the years, the "feel free" spending amount can increase, possibly substantially.
Undoubtedly, this could be frustrating to people who want to spend more money in the early years of their retirement while they're still healthy. One possible solution to this problem is to spend at the "feel free" rate to cover your basic living expenses, and then work part time in the early years of your retirement while you're still able, to cover your discretionary living expenses.
This can be your "mad money" -- your spending on traveling, hobbies or spoiling your grandchildren.
Inglis also outlines a "no more" spending rate, which is equal to your age divided by 10. For example, 70-year-0ld retirees should spend no more than 7 percent (70 divided by 10) of their savings in a single year.
Spending at the "no more" rate for many years will most likely result in a declining rate of spending over time due to spending down your savings too rapidly. The "no more" spending rate serves as an upper limit for a given year, but it's not recommended that a retiree spend at this rate indefinitely.
A retiree can obtain a guaranteed, lifetime level of income that's close to the "no more" rate by buying a low-cost immediate annuity. Buying an annuity from a highly rated insurance company is one safe way to boost your income above the "feel free" spending rate.
One word of caution regarding the "feel free" rate of spending: If you've invested your savings in an IRA or 401(k) plan that's subject to the IRS required minimum distribution (RMD) rules, in most situations, the "feel free" spending amount will be less than the amounts required by the RMD. So you'll need to withdraw at least the RMD amounts from your savings.
You don't need to spend that amount -- you just need to withdraw it and include it in your taxable income for the year. Amounts invested in Roth IRAs and nonretirement accounts aren't subject to the RMD rules.
The IRS RMD withdrawal amount has a few advantages: IRA and 401(k) administrators can calculate it for you, and it's also intended to make your money last for life. As it turns out, the IRS RMD results in lower withdrawal amounts than the "no more" spending rate until age 90. Thereafter, it produces higher withdrawal amounts.
So retirees who want to spend more than the "feel free" spending rate could design a withdrawal strategy that ranges between the "feel free" and the RMD rates. This will keep their spending below the "no more" rate until age 90.
There are many other reasonable ways to generate retirement income from your savings. And Inglis acknowledges many other considerations can come into play when developing a retirement income strategy. So his essay also provides details about these considerations as well as examples of how to best apply his spending rules.
Said Inglis: "The feel-free spending level is an easy-to-determine and -remember guideline for those who do not have the time, expertise or inclination to do a lot of analysis and who don't want to hire an adviser for help."