We all work hard to put away money for retirement, but it can be hard to know when we have enough to actually pull the trigger and retire.
Because after all, if we made a list of all the bad things that could happen in retirement, running out of money would certainly be up there.
While there is no way to predict the future, there are strategies that we can use to help us know when we can retire and never run out of money.
How To Never Run Out of Money
Before we can answer the question of “Do I have enough to retire?”, we first have to know how much income your money can safely provide you in retirement. From there, you can decide if that level of income is sufficient for you to live comfortably (along with your other sources of income).
There are 3 investment withdrawal strategies that I’ll describe below that many people use in retirement.
Don’t Touch Your Principal
One strategy that is used in retirement to ensure that you will never run out of money is when you only live off the earnings of your investments and never touch your principal.
For example, if you have $500k saved for retirement, you would only spend the income that the $500k earned if you followed this strategy. So if your $500k grew to $550k, then you would be able to spend the $50k of growth that year.
This strategy is guaranteed to work because if you never touch your original investment it will always be there to produce more income for you.
However, the downside of this strategy is the fact that there may be years that your investments lose value. In these years, your investments would not have any growth and you wouldn’t be able to use any of it to live off of.
As a result, this strategy works well when your investments see steady growth but certainly doesn’t work as well when your investments experience some volatility.
Another criticism for this strategy is that some people would like to enjoy their money to the fullest and have no interest in leaving their original investment behind when they pass away.
The next withdrawal strategy that is often used in retirement is the 4% rule.
This rule states that in the first year of retirement, someone can take a withdrawal of 4% of their investments. In subsequent years after that they can adjust their withdrawal for inflation every year.
For example, if you start with $500k at retirement, you would be able to withdraw $20,000 the first year. The second year, if there was inflation of 5% then you would be able to withdraw $21,000.
If someone follows the 4% rule then the odds of them running out of money are very small.
Note: The 4% rule assumes that a retiree is investing their money in 50% stocks (C, S, and I Funds) and 50% bonds (G and F Funds).
Some criticism of the 4% rule is that in a favorable investing period someone can afford to withdraw much more than 4% and still be fine (and this is certainly true). However, the 4% rule is meant to be a rule that can be followed successfully during any time period (even when the market is doing really bad).
If you are still working, then a useful application of the 4% rule would be to show you how much your current savings amount would provide if you retired.
The last strategy that we’ll discuss here is a dynamic distribution strategy. As the name implies, this strategy allows you to withdraw different amounts from your investments depending on how your investments have been performing.
Basically, this strategy says that you can take more out of your investments when the market is doing well but to cut back when the market is down.
The exact % of how much this strategy allows you to spend every year does differ depending on the source, so feel free to learn more by Googling “dynamic distribution withdrawals”.
The downside of this strategy is that you would have to be okay with cutting back on your budget in years when the market is doing poorly. The upside, however, is that you would be able to spend much more in the good years.
Don’t forget about Taxes
As always, when running your retirement numbers, make sure you include taxes in the equation.
For example, if the 4% rule says you can spend $40,000/year from your $1,000,000 retirement nest egg, then just remember that it may only be $32,000 after you pay taxes (assuming you are taking money from a pre-tax account).
While there is no way to know what taxes and the market are going to be in the future, it always helps to start planning for the future today.