With the average length of retirement spanning 20 years or more these days, there’s a very real chance you may live longer than your retirement fund. Fifty years ago, many people retired at age 65 and lived to age 68. Today, thanks to improved standards of living and advanced medical breakthroughs, people are living well into their eighties and beyond. This means you need more money to live out your retirement years comfortably—a lot more money.
When people in their eighties or nineties realize their retirement fund is almost dry, they can experience much emotional turmoil. Few enjoy change, and as you get older, change becomes more difficult. Moving in with an adult child or downsizing to a smaller home are major lifestyle changes that cause more stress, sadness and adjustment difficulties in older people than in younger ones. That’s why you need to be sure you’ll have enough money to last you throughout your golden years.
Even high net worth individuals need to look at this issue. Just because they’re financially set doesn’t mean they’re immune to running out of money later in life, especially if their lifestyle consumes a significant portion of their assets.
Unfortunately, few people take the time to calculate how much money they’ll need during retirement or how long their current retirement fund will last. After all, no one wants to sit down with graphs, charts and calculators and do math. Doing so would force you to face your own mortality—a thought few people like to entertain.
But to be sure you won’t outlive your money and have to make some tough decisions later in life, you need to take a few steps today that will let you maximize your retirement fund. Consider the following suggestions.
1. Have a realistic timeframe. In the past, people believed longevity was completely heredity. Today, making that kind of assumption is unrealistic. Between new pharmaceuticals, more advanced medical care and healthier eating habits, many people will live a lot longer than their parents did. Therefore, for retirement planning purposes, always assume you will live into your nineties. If you don’t plan for it and you do live that long, you may run out of money. If you don’t live that long, you’ll have more assets to pass on to heirs.
2. Calculate everything. You need to have a clear picture of your situation. To calculate the amount of money you’ll have at retirement, include retirement funds (IRAs, Roths, 401Ks), pension plans, savings and checking accounts, real estate investment properties, social security benefits, inheritances and any other income. You want an accurate figure to work with, so don’t leave anything out.
3. Beware of inflation. Inflation is the silent killer of your ability to pull large sums of money from your retirement funds. With inflation, everything costs more money. Suppose you’re in your early fifties and have a $3 million portfolio. That’s a nice nest egg that should support you for many years. However, 10 years from now, that $3 million won’t have as much purchasing power. So be aware of the inflation rate and take it into consideration. What looks like a lot of money today won’t pack the same punch in the future.
4. Use a prudent withdrawal rate. Since the late 1990s, independent studies using both historical market data and Monte Carlo projections of future market scenarios have shown that, even with optimal investment returns, retirees who take more than 6 percent a year from their portfolio over a 30-year period run a significant risk of running out of money. The studies consistently have shown the most prudent withdrawal rate in retirement is 4 percent of the initial portfolio, plus inflation.
For example, if you have a $3 million portfolio, you’d withdraw $120,000 the first year. If the consumer price index (CPI) rises 4 percent that year, you’d withdraw $124,800 ($120,000 plus 4 percent) in year two. If the CPI rises 2 percent the following year, your next withdrawal is $127,296, and so on. Four percent isn’t a large amount of money. That’s why you need to have ample money saved—probably a lot more than you think you’ll ever need.
5. Make your asset allocation work for you. Your asset allocation plays an important role in your retirement planning. If it’s too conservative, inflation erodes your purchasing power. Go too aggressive, and you might not be able to handle the bear market. In a nutshell, you can think of it as stocks versus bonds. The more your portfolio leans toward stocks, the more aggressive the allocation. Since stocks generate higher returns than bonds over the long run, you’ll end up with greater returns. However, you’ll also have more volatility during down markets. The more your portfolio leans toward bonds, the less aggressive the allocation. You’ll fare better during market downtimes, but over the long haul, you’ll have lower returns.
The right allocation for you is based on your ability to handle risk versus your need to take risk. A 50/50 asset allocation is a good starting point and does an adequate job of letting you take some risks without losing too much when you hit a down market. If you’re younger, time is on your side, so you can lean more toward stocks like a 60/40, 70/30 or greater asset allocation. Big downturns won’t hurt because you have plenty of time to let the market and your portfolio bounce back. However, the closer you are to retirement, or the larger the portfolio, the closer you want to stay to that 50/50 asset allocation number, or maybe even tilted more toward bonds.
It’s your future—plan for it
Your retirement should be a time of joyous opportunities. Don’t get caught off guard and run out of money later in life simply because you didn’t take time to plan. By considering these suggestions today and taking appropriate action, you’ll have a greater chance of being able to afford your lifestyle throughout all your retirement years.
Timothy J. Delaney is managing director of JDH Wealth Management, LLC in Santa Rosa. He works with high net worth clients who want to simplify their financial life so they can pursue their retirement dreams. Contact Tim at tdelaney@jdhwealth.com.
