Retirement Can Last a Very Long Time: Will Your Money Last as Long as You Do?
by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
July 8, 2009
All the articles I see about planning for retirement seem to assume a 30-year retirement. I’m hoping to retire in three years at 62, so that’s probably fine for me. But my non-working wife, 55, has had numerous relatives live well into their 90s, so planning for 40 years of retirement income for her seems prudent. How does the 4% rule change for that scenario? Thanks
Great question! You’re right, of course, that 30 years seems to be the “standard” length of retirement these days, but people are living longer and longer and 35 or 40 years is certainly not unheard of. Your question also mentions a common and useful guideline, often called “the 4% rule,” which can help you estimate the amount of money you can safely withdraw each year over a 30-year retirement.
A quick example: If you had a $1 million portfolio and were retiring today, the 4% rule suggests that you could safely withdraw 4% ($40,000) in year one, and increase that amount every year with inflation. By following this guideline, you should have about a 90% probability that you won’t outlive your money. (In other words, in the first year of retirement your budget would be $40,000 plus Social Security benefits plus pensions or other income you might reliably count on.)
I should note here that some investment strategists have revised the 4% figure downward given the dramatic declines in the market and their more tempered expectations for stock market performance going forward. They suggest that conservative investors might use 3.7% as their first-year withdrawal amount. That may not sound like a huge difference, but it means you’d take out $37,000 instead of $40,000—a $3,000 decline in your standard of living.
But your question is different. What if you want to plan for a 40 years of retirement instead of 30 years
? Common sense suggests that you would need to take out less money in year one if you want your capital to last an additional 10 years (10 years may not sound like much; but a 40-year retirement is a full third longer than a 30-year retirement) with the same degree of confidence. Now the Monte Carlo analysis generates a much lower number, down to 3.1%, for your first-year withdrawal. Again, given a hypothetical $1 million portfolio, that means you could take out $31,000 in year one if you want to be reasonably confident that you won’t outlive your money (i.e., have a 90% chance). There are a lot of assumptions built into these calculations, including a moderately aggressive portfolio, 60% in stocks/40% in bonds and cash.
You’re smart to think about the length of your retirement as you plan your financial future. And I always think it’s wise to err on the side of caution and prudence, in this case assuming a longer retirement. I would suggest you run your numbers with a 3.1% first-year withdrawal rate, and see how that affects your retirement budget.
Obviously, using a factor of 3.1% instead of 4% will have an impact. But there are other things you can think about to counter-balance it — like working part-time or delaying taking Social Security to get a bigger benefit later. You might also think about consulting with a financial advisor, if for no other reason than to confirm your own calculations and investment choices. Clearly, it’s better to understand the fine points now, rather than discover them down the road. Best of luck.
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