What's Your Number? How Much Do You Need to Retire? - Part 2 - Steps 2 and 3
What's Your Number? How Much Money Do You Need to Retire? - Part 2
Step 2: Determine "Safe Withdrawal Rate"
The topic of "safe withdrawal rates" has been studied extensively by many financial professionals over the years. It is generally accepted that a safe initial withdrawal rate from a portfolio should fall between 3 and 5 percent to give the portfolio the greatest chance to last for approximately 30 or more years. This means that on a million dollar portfolio, one could take out between $30,000 and $50,000 in the first year with annual increases of 3-4% inflation each year thereafter, and have reasonable odds that the portfolio will not be depleted prior to 30 years. The longer the expected time horizon, the lower the initial withdrawal rate should be. For example, if you retire at age 55 and expect to live until age 95, you would likely want to plan on an initial withdrawal rate closer to 3%. The expected rate of investment return for the portfolio also has a significant impact. If the investment return is expected to be 6% (2% or 3% above inflation), a lower initial rate of 3-4% should be used. If the expected annual return is above 9% (5% or 6% above inflation), you may be able to use an initial withdrawal rate of 5% and not outlive your assets over a 30-year period of time. Substantial negative investment returns during the first few years of taking withdrawals can also have a large impact. It is important to emphasize that the investment returns generated have an enormous impact on sustainable withdrawal rates. Since we cannot predict future investment returns, it is important to have the flexibility to adjust your annual withdrawals if you experience an adverse investment environment.
Step 3: Calculate Your Number
After figuring out your anticipated expenses for your first year in retirement as well as a sustainable initial withdrawal rate, the calculation of your number can be quite easy. Simply take the anticipated withdrawal needed from personal savings in your first year of retirement (making sure you are using the future dollars conversion), divide by the withdrawal rate (for instance, use .04 for 4% initial withdrawal rate) and you will get your number.
For example, if your first year retirement withdrawal is $50,000, divide it by .04 (assuming your time span and investment returns are reasonable for a 4% initial withdrawal rate) and your number is $1,250,000.
If you are able to determine your realistic number, the next step would be to figure out if you are on track to obtain that number when you retire. Since the process outlined above includes many variables and is complicated, it is strongly encouraged to seek the advice of a Certified Financial Planner® professional. Financial security is too important, and obtaining the appropriate advice can make a huge difference to achieving fiscal prosperity in retirement.
Tracy Burke, CFP, ChFC
Conrad Siegel Investment Advisors, Inc. Harrisburg PA